Back to GetFilings.com



Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

QUARTERLY PERIOD ENDED June 30, 2004

 

Commission File Number 0-2525

 


 

Huntington Bancshares Incorporated

 


 

Maryland   31-0724920

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

41 South High Street, Columbus, Ohio 43287

 

Registrant’s telephone number (614) 480-8300

 


 

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 and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

There were 229,685,385 shares of Registrant’s without par value common stock outstanding on July 31, 2004.

 



Table of Contents

Huntington Bancshares Incorporated

 

INDEX

 

Part I.

   Financial Information     

Item 1.

   Financial Statements (Unaudited)     
     Condensed Consolidated Balance Sheets at June 30, 2004, December 31, 2003, and June 30, 2003    3
     Condensed Consolidated Statements of Income for the three and six months ended June 30, 2004 and 2003    4
     Condensed Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2004 and 2003    5
     Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003    6
     Notes to Unaudited Condensed Consolidated Financial Statements    7

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    18

Item 3.

   Quantitative and Qualitative Disclosures about Market Risk    74

Item 4.

   Controls and Procedures    74

Part II.

   Other Information     

Item 2.

   Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities    75

Item 4.

   Submission of Matters to a Vote of Shareholders    75

Item 6.

   Exhibits and Reports on Form 8-K    76

Signatures

   77

 

2


Table of Contents

Part 1. Financial Information

Item 1. Financial Statements

Huntington Bancshares Incorporated

Condensed Consolidated Balance Sheets

 

(in thousands, except number of shares)


  

June 30,

2004


   

December 31,

2003


   

June 30,

2003


 
     (Unaudited)           (Unaudited)  

Assets

                        

Cash and due from banks

   $ 1,162,995     $ 899,689     $ 1,153,108  

Federal funds sold and securities purchased under resale agreements

     193,772       96,814       74,473  

Interest bearing deposits in banks

     24,009       33,627       44,906  

Trading account securities

     20,577       7,589       19,426  

Loans held for sale

     314,262       226,729       713,722  

Securities available for sale - at fair value

     4,988,270       4,925,232       3,702,761  

Investment securities held to maturity - fair value $3,224; $3,937 and $6,780, respectively

     3,169       3,828       6,593  

Loans and leases

     21,775,669       21,075,118       19,059,533  

Allowance for loan and lease losses

     (286,935 )     (299,732 )     (307,667 )
    


 


 


Net loans and leases

     21,488,734       20,775,386       18,751,866  
    


 


 


Operating lease assets

     888,612       1,260,440       1,672,608  

Bank owned life insurance

     944,892       927,671       906,823  

Premises and equipment

     354,534       349,712       332,916  

Goodwill and other intangible assets

     216,215       217,009       218,080  

Customers’ acceptance liability

     6,613       9,553       8,372  

Accrued income and other assets

     814,552       786,047       731,559  
    


 


 


Total Assets

   $ 31,421,206     $ 30,519,326     $ 28,337,213  
    


 


 


Liabilities

                        

Deposits

   $ 19,465,146     $ 18,487,395     $ 18,371,359  

Short-term borrowings

     1,130,830       1,452,304       918,771  

Federal Home Loan Bank advances

     1,270,455       1,273,000       1,273,000  

Other long-term debt

     4,557,373       4,544,509       3,508,397  

Subordinated notes

     1,011,506       990,470       496,666  

Company obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely junior subordinated debentures of the parent company

     —         —         300,000  

Allowance for unfunded loan commitments and letters of credit

     31,193       35,522       33,280  

Bank acceptances outstanding

     6,613       9,553       8,372  

Accrued expenses and other liabilities

     1,561,721       1,451,571       1,225,169  
    


 


 


Total Liabilities

     29,034,837       28,244,324       26,135,014  
    


 


 


Shareholders’ Equity

                        

Preferred stock - authorized 6,617,808 shares; none outstanding

     —         —         —    

Common stock - without par value; authorized 500,000,000 shares; issued 257,866,255 shares; outstanding 229,475,821; 229,008,088 and 228,660,038 shares, respectively

     2,482,069       2,483,542       2,483,105  

Less 28,390,434; 28,858,167 and 29,206,217 treasury shares, respectively

     (539,852 )     (548,576 )     (555,176 )

Accumulated other comprehensive income (loss)

     (27,204 )     2,678       40,817  

Retained earnings

     471,356       337,358       233,453  
    


 


 


Total Shareholders’ Equity

     2,386,369       2,275,002       2,202,199  
    


 


 


Total Liabilities and Shareholders’ Equity

   $ 31,421,206     $ 30,519,326     $ 28,337,213  
    


 


 


 

See notes to unaudited condensed consolidated financial statements

 

3


Table of Contents

Huntington Bancshares Incorporated

Condensed Consolidated Statements of Income

(Unaudited)

 

     Three Months Ended
June 30,


   

Six Months Ended

June 30,


 

(in thousands, except per share amounts)


   2004

    2003

    2004

   2003

 

Interest and fee income

                               

Loans and leases

                               

Taxable

   $ 268,409     $ 265,694     $ 538,771    $ 535,939  

Taxable-exempt

     444       675       950      1,409  

Securities

                               

Taxable

     43,926       37,014       88,072      74,139  

Taxable-exempt

     7,247       5,019       14,760      9,972  

Other

     4,141       8,923       7,545      15,880  
    


 


 

  


Total Interest Income

     324,167       317,325       650,098      637,339  
    


 


 

  


Interest expenses

                               

Deposits

     59,372       76,383       118,998      156,093  

Short-term borrowings

     2,789       4,313       6,102      9,872  

Federal Home Loan Bank advances

     8,098       5,634       16,139      11,219  

Subordinated notes and other long-term debt including preferred capital securities

     31,345       28,554       63,611      55,955  
    


 


 

  


Total Interest Expense

     101,604       114,884       204,850      233,139  
    


 


 

  


Net Interest Income

     222,563       202,441       445,248      404,200  

Provision for credit losses

     5,027       49,193       30,623      86,037  
    


 


 

  


Net Interest Income After Provision for Credit Losses

     217,536       153,248       414,625      318,163  
    


 


 

  


Operating lease income

     78,706       128,574       167,573      266,767  

Service charges on deposit accounts

     43,596       40,914       85,433      80,783  

Trust services

     16,708       15,580       33,031      30,491  

Brokerage and insurance income

     13,523       14,196       28,720      29,693  

Mortgage banking

     23,322       7,185       19,026      18,310  

Bank owned life insurance income

     11,309       11,043       21,794      22,180  

Gain on sales of automobile loans

     4,890       13,496       13,894      23,751  

Other service charges and fees

     10,645       11,372       20,158      21,710  

Securities gains (losses)

     (9,230 )     6,887       5,860      8,085  

Other

     24,659       27,704       50,278      48,105  
    


 


 

  


Total Non-Interest Income

     218,128       276,951       445,767      549,875  
    


 


 

  


Personnel costs

     119,715       105,242       241,339      218,331  

Operating lease expense

     62,563       102,939       133,273      214,527  

Outside data processing and other services

     17,563       16,104       36,025      32,683  

Equipment

     16,228       16,341       32,314      32,753  

Net occupancy

     16,258       15,377       33,021      31,986  

Professional services

     7,836       9,872       15,135      19,157  

Marketing

     8,069       8,454       15,908      15,080  

Telecommunications

     4,638       5,394       9,832      11,095  

Printing and supplies

     3,098       2,253       6,114      5,934  

Amortization of intangibles

     204       204       408      408  

Restructuring reserve releases

     —         (5,315 )     —        (6,315 )

Other

     25,981       20,168       44,438      36,873  
    


 


 

  


Total Non-Interest Expense

     282,153       297,033       567,807      612,512  
    


 


 

  


Income Before Income Taxes

     153,511       133,166       292,585      255,526  

Provision for income taxes

     43,384       36,676       78,285      67,306  
    


 


 

  


Net Income

   $ 110,127     $ 96,490     $ 214,300    $ 188,220  
    


 


 

  


Average Common Shares:

                               

Basic

     229,429       228,633       229,328      229,987  

Diluted

     232,659       230,572       232,787      231,684  

Per Common Share:

                               

Net Income - Basic

   $ 0.48     $ 0.42     $ 0.93    $ 0.82  

Net Income - Diluted

     0.47       0.42       0.92      0.81  

Cash Dividends Declared

     0.175       0.16       0.35      0.32  

 

See notes to unaudited condensed consolidated financial statements

 

4


Table of Contents

Huntington Bancshares Incorporated

Consolidated Statements of Changes in Shareholders’ Equity

 

(in thousands)


  Common Stock

    Treasury Shares

   

Accumulated

Other

Comprehensive

Income


   

Retained
Earnings


   

Total


 
  Shares

  Amount

    Shares

    Amount

       

Six Months Ended June 30, 2003 (Unaudited):

                                                 

Balance, beginning of period

  257,866   $ 2,484,421     (24,987 )   $ (475,399 )   $ 62,300     $ 118,471     $ 2,189,793  

Comprehensive Income:

                                                 

Net income

                                      188,220       188,220  

Unrealized net holding losses on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income

                              (4,391 )             (4,391 )

Unrealized losses on derivative instruments used in cash flow hedging relationships

                              (17,092 )             (17,092 )
                                             


Total comprehensive income

                                              166,737  
                                             


Cash dividends declared ($0.32 per share)

                                      (73,238 )     (73,238 )

Stock options exercised

        (1,316 )   118       1,902                       586  

Treasury shares purchased

              (4,300 )     (81,061 )                     (81,061 )

Other

              (37 )     (618 )                     (618 )
   
 


 

 


 


 


 


Balance, end of period (Unaudited)

  257,866   $ 2,483,105     (29,206 )   $ (555,176 )   $ 40,817     $ 233,453     $ 2,202,199  
   
 


 

 


 


 


 


Six Months Ended June 30, 2004 (Unaudited):

                                                 

Balance, beginning of period

  257,866   $ 2,483,542     (28,858 )   $ (548,576 )   $ 2,678     $ 337,358     $ 2,275,002  

Comprehensive Income:

                                                 

Net income

                                      214,300       214,300  

Unrealized net holding losses on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income

                              (52,165 )             (52,165 )

Unrealized gains on derivative instruments used in cash flow hedging relationships

                              22,283               22,283  
                                             


Total comprehensive income

                                              184,418  
                                             


Cash dividends declared ($0.35 per share)

                                      (80,302 )     (80,302 )

Stock options exercised

        (951 )   442       8,467                       7,516  

Other

        (522 )   26       257                       (265 )
   
 


 

 


 


 


 


Balance, end of period (Unaudited)

  257,866   $ 2,482,069     (28,390 )   $ (539,852 )   $ (27,204 )   $ 471,356     $ 2,386,369  
   
 


 

 


 


 


 


 

See notes to unaudited condensed consolidated financial statements.

 

5


Table of Contents

Huntington Bancshares Incorporated

Consolidated Statements of Cash Flows

(Unaudited)

 

     Six Months Ended June 30,

 

(in thousands)


   2004

    2003

 

Operating Activities

                

Net Income

   $ 214,300     $ 188,220  

Adjustments to reconcile net income to net cash provided by operating activities

                

Provision for credit losses

     30,623       86,037  

Depreciation on operating lease assets

     132,388       187,914  

Other depreciation and amortization

     38,995       42,209  

Deferred income tax expense

     66,243       31,479  

Increase in trading account securities

     (12,988 )     (19,185 )

Increase in mortgages held for sale

     (87,783 )     (185,343 )

Gains on sales of securities available for sale

     (5,860 )     (8,085 )

Gains on sales/securitizations of loans

     (15,407 )     (30,797 )

Restructuring reserve releases

     —         (6,315 )

Other, net

     (8,146 )     (68,002 )
    


 


Net Cash Provided by Operating Activities

     352,365       218,132  
    


 


Investing Activities

                

Decrease (increase) in interest bearing deposits in banks

     9,618       (7,606 )

Proceeds from:

                

Maturities and calls of investment securities held to maturity

     670       954  

Maturities and calls of securities available for sale

     544,419       945,534  

Sales of securities available for sale

     885,554       591,497  

Purchases of securities available for sale

     (1,457,477 )     (1,649,721 )

Proceeds from sales/securitizations of loans

     1,382,596       1,390,378  

Net loan and lease originations, excluding sales

     (2,234,989 )     (2,119,933 )

Net decrease in operating lease assets

     240,523       340,003  

Proceeds from sale of premises and equipment

     334       4,049  

Purchases of premises and equipment

     (29,298 )     (22,220 )

Proceeds from sales of other real estate

     6,460       4,872  
    


 


Net Cash Used for Investing Activities

     (651,590 )     (522,193 )
    


 


Financing Activities

                

Increase in deposits

     982,401       869,313  

Decrease in short-term borrowings

     (321,474 )     (1,222,245 )

Proceeds from issuance of subordinated notes

     148,830       —    

Maturity of subordinated notes

     (100,000 )     (250,000 )

Proceeds from Federal Home Loan Bank advances

     455       270,000  

Maturity of Federal Home Loan Bank advances

     (3,000 )     (10,000 )

Proceeds from issuance of long-term debt

     625,000       1,235,000  

Maturity of long-term debt

     (600,000 )     (225,000 )

Dividends paid on common stock

     (80,239 )     (73,714 )

Repurchases of common stock

     —         (81,061 )

Net proceeds from issuance of common stock

     7,516       586  
    


 


Net Cash Provided by Financing Activities

     659,489       512,879  
    


 


Change in Cash and Cash Equivalents

     360,264       208,818  

Cash and Cash Equivalents at Beginning of Period

     996,503       1,018,763  
    


 


Cash and Cash Equivalents at End of Period

   $ 1,356,767     $ 1,227,581  
    


 


Supplemental disclosures:

                

Income taxes paid

   $ 9,490     $ 65,859  

Interest paid

     206,500       247,126  

Non-cash activities

                

Residential mortgage loans securitized and retained in securities available for sale

     115,929       171,586  

Common stock dividends accrued not paid

     31,562       27,932  

 

See notes to unaudited condensed consolidated financial statements.

 

6


Table of Contents

Notes to Unaudited Condensed Consolidated Financial Statements

 

Note 1 – Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of Huntington Bancshares Incorporated (Huntington) reflect all adjustments consisting of normal recurring accruals, which are, in the opinion of Management, necessary for a fair presentation of the consolidated financial position, the results of operations, and cash flows for the periods presented. These unaudited condensed consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission (SEC) and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been omitted. The Notes to the Consolidated Financial Statements appearing in Huntington’s 2003 Annual Report on Form 10-K (2003 Form 10-K), which include descriptions of significant accounting policies, as updated by the information contained in this report, should be read in conjunction with these interim financial statements.

 

Certain amounts in the prior year’s financial statements have been reclassified to conform to the 2004 presentation.

 

For statement of cash flows purposes, cash and cash equivalents are defined as the sum of “Cash and due from banks” and “Federal funds sold and securities purchased under resale agreements”.

 

Note 2 – New Accounting Pronouncements

 

Emerging Issues Task Force Issue No. 03-1, The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments (EITF 03-1): The Emerging Issues Task Force reached a consensus about the criteria that should be used to determine when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. EITF 03-1 also included accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. EITF 03-1 will apply to the evaluation of other-than-temporary impairment in reporting periods beginning after June 15, 2004.

 

At June 30, 2004, Huntington had $3.3 billion of securities whose fair value was less than book value. The unrealized loss in these securities totaled $88.9 million. Of these securities, Huntington held $3.1 billion of securities, with an unrealized loss of $80.0 million, where the security cannot be contractually prepaid or where Huntington would recover substantially all of its cost if the securities were contractually prepaid. Management continues to evaluate its options with respect to adopting this new accounting guidance and cannot currently estimate the impact of adopting EITF 03-1.

 

Emerging Issues Task Force Issue No. 03-16, Accounting for Investment in Limited Liability Companies (EITF 03-16): The Task Force reached a consensus that an investment in a limited liability company (LLC) that maintains a “specific ownership account” for each investor should be viewed as similar to an investment in a limited partnership for purposes of determining whether a noncontrolling investment in an LLC should be accounted for using the cost method or the equity method. The current rules require a noncontrolling investment in a limited partnership to be accounted for under the equity method unless the interest is so minor that the limited partner may have virtually no influence over the partnership operating and financial policies. The guidance for evaluating an investment in a LLC should be applied for reporting periods beginning after June 15, 2004. The impact of EITF 03-16 is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.

 

SEC Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments (SAB 105): On March 9, 2004, the SEC issued SAB 105, which summarizes the views of the SEC staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments. Specifically, SAB 105 indicated that the fair value of loan commitments that are required to follow derivative accounting under FAS 133, Accounting for Derivative Instruments and Hedging Activities, should not consider the expected future cash flows related to the associated servicing of the future loan. Prior to SAB 105, Huntington did not consider the expected future cash flows related to the associated servicing in determining the fair value of loan commitments. The adoption of SAB 105 did not have a material effect on Huntington’s financial results.

 

7


Table of Contents

FASB Staff Position No. 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FSP 106-2): In December 2003, a law was approved that expands Medicare benefits, primarily adding a prescription drug benefit for Medicare-eligible retirees beginning in 2006. The law also provides a federal subsidy to companies that sponsor postretirement benefit plans providing prescription drug coverage. FSP 106-2 was issued in May 2004 and supersedes FSP 106-1 issued in January 2004. FSP 106-2 specifies that any Medicare subsidy must be taken into account in measuring the employer’s postretirement health care benefit obligation and will also reduce the net periodic postretirement cost in future periods. The new guidance is effective for the reporting periods beginning on or after June 15, 2004. Accordingly, the postretirement benefit obligations and net periodic costs reported in the accompanying financial statements and notes do not reflect the impact of this legislation. The impact of this new pronouncement is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.

 

AICPA Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3): In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP 03-3 to address accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when loans or debt securities are acquired in a transfer and those cash flow differences are attributable, at least in part, to credit quality. As such, SOP 03-3 applies to loans and debt securities acquired in purchase business combinations and does not apply to originated loans. The application of SOP 03-3 limits the interest income, including accretion of purchase price discounts, that may be recognized for certain loans and debt securities. Additionally, SOP 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield or valuation allowance, such as the allowance for credit losses. Subsequent to the initial investment, increases in expected cash flows generally should be recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. SOP 03-3 is effective for loans and debt securities acquired in fiscal years beginning after December 15, 2004, with early application encouraged. The impact of this new pronouncement is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.

 

FASB Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure (FAS 148): FAS 148 was issued in December 2002, as an amendment of Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition to FAS 123’s fair value method of accounting for stock-based employee compensation. FAS 148 also amends the disclosure provisions of FAS 123 and Accounting Principles Board (APB) Opinion No. 28, Interim Financial Reporting (APB 28), to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While FAS 148 does not require companies to account for employee stock options using the fair value method, the disclosure provisions of FAS 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of FAS 123 or the intrinsic value method of APB 25, which is the method currently used by Huntington. See note 11 for the disclosures.

 

Note 3 – Securities and Exchange Commission Investigation

 

As previously disclosed, the Securities and Exchange Commission (SEC) is conducting a formal investigation regarding certain financial accounting and disclosure matters, including certain matters that were the subject of prior restatements by Huntington. The SEC staff has notified Huntington that the staff is considering recommending to the SEC that it institute enforcement action against Huntington and certain of its senior officers for, among other possible matters, violations of various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933 in connection with certain financial accounting matters relating to fiscal years 2002 and earlier, and certain related disclosure matters.

 

Huntington is presently in negotiations with the staff of the SEC regarding a settlement of its investigation. Huntington’s chief executive officer has indicated he accepts responsibility in his position as the chief executive officer for matters that occur on his watch, and has indicated a willingness to negotiate a settlement with the SEC of these matters. Huntington expects that a settlement of this matter would involve the entry of an order requiring, among other possible matters, Huntington to comply with various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933, along with the imposition of a fine and other possible measures. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.

 

Huntington also remains in active dialogue with its bank regulators concerning these matters and is working diligently with the regulators to resolve them in a manner that permits it to proceed with its pending Unizan acquisition. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.

 

Donald R. Kimble, who joined Huntington earlier this year as executive vice president in the Finance area, has been named chief financial officer and controller. Prior to joining Huntington, Kimble was executive vice president and controller of AmSouth Bancorporation, and previously held various subsidiary chief financial officer or accounting positions at Bank One Corporation. Michael J. McMennamin and John D. Van Fleet have relinquished their positions of chief financial officer and controller, respectively. Both remain with the company.

 

8


Table of Contents

Note 4 – Pending Acquisition

 

On January 27, 2004, Huntington announced the signing of a definitive agreement to acquire Unizan Financial Corp. (Unizan), a financial holding company based in Canton, Ohio, with $2.7 billion of assets at December 31, 2003. Under the terms of the agreement, Unizan shareholders will receive 1.1424 shares of Huntington common stock, on a tax-free basis, for each share of Unizan. Based on the $23.10 closing price of Huntington’s common stock on January 26, 2004, this represented a price of $26.39 per Unizan share, and valued the transaction at approximately $587 million. Both boards unanimously approved the merger, and on May 25, 2004, Unizan shareholders approved the merger. Approval by Huntington shareholders is not required.

 

As reported on June 16, 2004, the Federal Reserve Board had informed Huntington that it had extended its review period to coordinate further with the staff of the SEC regarding the SEC’s ongoing formal investigation of Huntington and to complete its review of the Community Reinvestment Act aspects of the merger. Huntington remains in active dialogue with its bank regulators concerning these matters and is working diligently with the regulators to resolve them in a manner that permits it to proceed with its pending Unizan acquisition. No assurances, however, can be provided as to the ultimate timing or outcome of these matters (see Note 3 for additional discussion).

 

Huntington and Unizan are ready to close the merger, subject to the receipt of all necessary regulatory approvals. After the merger, Huntington also intends to purchase approximately 2.5 million common shares from time-to-time in the open market or through privately negotiated transactions depending on market conditions, to offset the dilutive effect of issuing shares to Unizan shareholders.

 

Note 5 – Stock Repurchase Plan

 

Effective April 27, 2004, the board of directors authorized a new share repurchase program (the 2004 Repurchase Program) which cancelled the 2003 Repurchase Program and authorized Management to repurchase not more than 7,500,000 shares of Huntington common stock. Any share repurchases will be made under this authorization. Purchases will be made from time-to-time in the open market or through privately negotiated transactions depending on market conditions. No share repurchases were made under the 2004 repurchase program.

 

Note 6 – Operating Lease Assets

 

Operating lease assets at June 30, 2004, December 31, 2003, and June 30, 2003, were as follows:

 

(in thousands)


   June 30,
2004


    December 31,
2003


    June 30,
2003


 

Cost of assets under operating leases

   $ 1,629,552     $ 2,136,502     $ 2,689,413  

Deferred lease origination fees and costs

     (1,033 )     (2,117 )     (44,586 )

Accumulated depreciation

     (739,907 )     (873,945 )     (972,219 )
    


 


 


Operating Lease Assets, Net

   $ 888,612     $ 1,260,440     $ 1,672,608  
    


 


 


 

Depreciation and residual losses at termination related to operating lease assets was $57.4 million and $91.4 million for the three months ended June 30, 2004 and 2003, respectively. For the respective six-month periods, depreciation and residual losses at termination was $121.3 million and $190.7 million.

 

9


Table of Contents

Note 7 – Securities Available for Sale

 

Securities available for sale at June 30, 2004, December 31, 2003, and June 30, 2003 were as follows:

 

     June 30, 2004

   December 31, 2003

   June 30, 2003

(in thousands of dollars)


   Amortized
Cost


   Fair Value

   Amortized
Cost


   Fair Value

   Amortized
Cost


   Fair Value

U.S. Treasury

                                         

Under 1 year

   $ 796    $ 800    $ 1,374    $ 1,376    $ 327    $ 331

1-5 years

     24,480      24,404      31,356      31,454      38,930      39,543

6-10 years

     754      824      271,271      275,540      64,063      66,158

Over 10 years

     —        —        —        —        —        —  
    

  

  

  

  

  

Total U.S. Treasury

     26,030      26,028      304,001      308,370      103,320      106,032
    

  

  

  

  

  

Federal Agencies

                                         

Mortgage backed securities

                                         

1-5 years

     14,181      14,548      19,899      20,434      23,879      24,661

6-10 years

     155,460      155,628      198,755      201,995      248,896      254,564

Over 10 years

     1,352,082      1,331,790      1,593,139      1,595,594      1,668,613      1,699,875
    

  

  

  

  

  

Total Mortgage-Backed

     1,521,723      1,501,967      1,811,793      1,818,023      1,941,388      1,979,100
    

  

  

  

  

  

Other Federal Agencies

                                         

Under 1 year

     116,357      118,776      173,181      175,505      137,797      141,375

1-5 years

     728,472      719,339      585,561      593,662      294,977      313,029

6-10 years

     343,226      322,398      403,953      390,164      171,343      169,976

Over 10 years

     —        —        201      192      —        —  
    

  

  

  

  

  

Total Other Agencies

     1,188,055      1,160,512      1,162,896      1,159,523      604,117      624,380
    

  

  

  

  

  

Total U.S. Treasury and Other Federal Agencies

     2,735,808      2,688,507      3,278,690      3,285,916      2,648,825      2,709,512
    

  

  

  

  

  

Municipal Securities

                                         

Under 1 year

     6,679      6,731      6,594      6,663      6,639      6,728

1-5 years

     14,191      14,424      20,015      20,569      20,402      21,150

6-10 years

     69,861      68,928      69,511      71,013      52,995      54,707

Over 10 years

     311,972      303,309      332,181      334,188      219,011      223,072
    

  

  

  

  

  

Total Municipal Securities

     402,703      393,391      428,301      432,433      299,047      305,657
    

  

  

  

  

  

Private Label CMO

                                         

Under 1 year

     —        —        1,973      1,973      —        —  

1-5 years

     —        —        —        —        —        —  

6-10 years

     —        —        —        —        —        —  

Over 10 years

     585,920      577,013      388,933      388,684      197,080      198,617
    

  

  

  

  

  

Total Private Label CMO

     585,920      577,013      390,906      390,657      197,080      198,617
    

  

  

  

  

  

Asset Backed Securities

                                         

Under 1 year

     —        —        —        —        —        —  

1-5 years

     30,000      30,038      30,000      29,944      30,000      29,944

6-10 years

     11,187      11,339      20,000      19,984      —        —  

Over 10 years

     1,074,239      1,075,608      590,826      589,788      96,875      96,693
    

  

  

  

  

  

Total Asset Backed Securities

     1,115,426      1,116,984      640,826      639,716      126,875      126,637
    

  

  

  

  

  

Other

                                         

Under 1 year

     1,611      1,642      500      502      1,081      1,003

1-5 years

     9,703      9,877      7,169      7,346      8,605      8,641

6-10 years

     2,854      2,948      5,047      5,510      4,994      5,267

Over 10 years

     193,652      190,545      145,103      146,685      136,226      132,948

Retained interest in securitizations

     —        —        5,593      6,356      148,177      163,664

Marketable equity securities

     6,658      7,364      8,547      10,111      50,809      50,815
    

  

  

  

  

  

Total Other

     214,479      212,375      171,959      176,510      349,892      362,338
    

  

  

  

  

  

Total Securities Available for Sale

   $ 5,054,335    $ 4,988,270    $ 4,910,682    $ 4,925,232    $ 3,621,719    $ 3,702,761
    

  

  

  

  

  

 

The growth from year-end and the year-ago quarter primarily consisted of over 10-year variable-rate asset backed securities.

 

10


Table of Contents

Note 8 – Segment Reporting

 

Huntington has three distinct lines of business: Regional Banking, Dealer Sales, and the Private Financial Group (PFG). A fourth segment includes Huntington’s Treasury functions and capital markets activities and other unallocated assets, liabilities, revenue, and expense. Line of business results are determined based upon Huntington’s management reporting system, which assigns balance sheet and income statement items to each of the business segments. The process is designed around Huntington’s organizational and management structure and, accordingly, the results below are not necessarily comparable with similar information published by other financial institutions.

 

Management relies on “operating earnings” for review of performance and for critical decision making purposes. Operating earnings exclude the impact of the significant items listed in the reconciliation table below. See Note 12 for further discussions regarding Restructuring Reserves.

 

The following provides a brief description of the four operating segments of Huntington:

 

Regional Banking: This segment provides products and services to retail, business banking, and commercial customers. These products and services are offered in seven operating regions within the five states of Ohio, Michigan, West Virginia, Indiana, and Kentucky through the company’s traditional banking network. Each region is further divided into Retail and Commercial Banking units. Retail products and services include home equity loans and lines of credit, first mortgage loans, direct installment loans, business loans, personal and business deposit products, as well as sales of investment and insurance services. Retail products and services comprise 57% and 81% of total Regional Banking loans and deposits, respectively. These products and services are delivered to customers through banking offices, ATMs, Direct Bank—Huntington’s customer service center, and Web Bank at huntington.com. Commercial banking serves middle-market and commercial banking relationships, which use a variety of banking products and services including, commercial loans, international trade, cash management, leasing, interest rate protection products, capital market alternatives, 401(k) plans, and mezzanine investment capabilities.

 

Dealer Sales: This segment serves automotive dealerships within Huntington’s primary banking markets, as well as in Arizona, Florida, Georgia, Pennsylvania, and Tennessee. This segment finances the purchase of automobiles by customers of the automotive dealerships, purchases automobiles from dealers and simultaneously leases the automobiles under long-term direct financing leases, finances dealership floor plan inventories, real estate, or working capital needs, and provides other banking services to the automotive dealerships and their owners.

 

Private Financial Group: This segment provides products and services designed to meet the needs of the company’s higher net worth customers. Revenue is derived through trust, asset management, investment advisory, brokerage, insurance, and private banking products and services.

 

Treasury/Other: This segment includes revenue and expense related to assets, liabilities, and equity that are not directly assigned or allocated to one of the three business segments. Assets included in this segment include bank owned life insurance, investment securities, and mezzanine loans originated through Huntington Capital Markets Group.

 

A match-funded transfer pricing system is used to attribute appropriate interest income and interest expense to other business segments. The Treasury/Other segment includes the net impact of interest rate risk management, including derivative activities. Furthermore, this segment’s results include the investment securities portfolios and capital markets activities. Additionally, income or expense and provision for income taxes, not allocated to other business segments, are also included.

 

11


Table of Contents

Listed below is certain reported financial information reconciled to Huntington’s three and six month 2004 and 2003 operating results by line of business.

 

     Three Months Ended June 30,

 

Income Statements

(in thousands)


   Regional
Banking


    Dealer
Sales


    PFG

    Treasury/
Other


    Huntington
Consolidated


 

2004

                                        

Net interest income

   $ 155,083     $ 43,586     $ 11,166     $ 12,728     $ 222,563  

Provision for credit losses

     3,949       (8,261 )     (654 )     (61 )     (5,027 )

Non-Interest income

     82,475       85,983       27,680       21,990       218,128  

Non-Interest expense

     (147,840 )     (85,768 )     (28,559 )     (19,986 )     (282,153 )

Provision for income taxes

     (32,783 )     (12,439 )     (3,372 )     5,210       (43,384 )
    


 


 


 


 


Net income, as reported

     60,884       23,101       6,261       19,881       110,127  

Gain on sale of automobile loans, net of tax

     —         (2,068 )     —         (1,110 )     (3,178 )
    


 


 


 


 


Operating Earnings

   $ 60,884     $ 21,033     $ 6,261     $ 18,771     $ 106,949  
    


 


 


 


 


2003

                                        

Net interest income

   $ 150,418     $ 11,639     $ 9,785     $ 30,599     $ 202,441  

Provision for credit losses

     (40,525 )     (9,191 )     457       66       (49,193 )

Non-Interest income

     71,790       153,303       27,850       24,008       276,951  

Non-Interest expense

     (143,319 )     (125,464 )     (25,886 )     (2,364 )     (297,033 )

Provision for income taxes

     (13,427 )     (10,600 )     (4,272 )     (8,377 )     (36,676 )
    


 


 


 


 


Net income, as reported

     24,937       19,687       7,934       43,932       96,490  

Gain on sale of automobile loans, net of tax

     —         (2,216 )     —         (6,556 )     (8,772 )

Restructuring releases, net of taxes

     —         —         —         (3,455 )     (3,455 )
    


 


 


 


 


Operating Earnings

   $ 24,937     $ 17,471     $ 7,934     $ 33,921     $ 84,263  
    


 


 


 


 


     Six Months Ended June 30,

 

Income Statements

(in thousands)


   Regional
Banking


    Dealer
Sales


    PFG

    Treasury/
Other


    Huntington
Consolidated


 

2004

                                        

Net interest income

   $ 306,145     $ 73,891     $ 22,295     $ 42,917     $ 445,248  

Provision for credit losses

     1,844       (29,916 )     (97 )     (2,454 )     (30,623 )

Non-Interest income

     154,526       196,538       56,307       38,396       445,767  

Non-Interest expense

     (294,932 )     (177,137 )     (58,020 )     (37,718 )     (567,807 )

Provision for income taxes

     (58,654 )     (22,182 )     (7,170 )     9,721       (78,285 )
    


 


 


 


 


Net income, as reported

     108,929       41,194       13,315       50,862       214,300  

Gain on sale of automobile loans, net of tax

     —         (8,214 )     —         (817 )     (9,031 )
    


 


 


 


 


Operating Earnings

   $ 108,929     $ 32,980     $ 13,315     $ 50,045     $ 205,269  
    


 


 


 


 


2003

                                        

Net interest income

   $ 296,832     $ 27,286     $ 19,280     $ 60,802     $ 404,200  

Provision for credit losses

     (64,078 )     (20,576 )     (1,443 )     60       (86,037 )

Non-Interest income

     143,389       311,819       55,063       39,604       549,875  

Non-Interest expense

     (283,623 )     (259,633 )     (52,521 )     (16,735 )     (612,512 )

Provision for income taxes

     (32,382 )     (20,614 )     (7,133 )     (7,177 )     (67,306 )
    


 


 


 


 


Net income, as reported

     60,138       38,282       13,246       76,554       188,220  

Gain on sale of automobile loans, net of tax

     —         (4,807 )     —         (10,631 )     (15,438 )

Restructuring releases, net of taxes

     —         —         —         (4,105 )     (4,105 )
    


 


 


 


 


Operating Earnings

   $ 60,138     $ 33,475     $ 13,246     $ 61,818     $ 168,677  
    


 


 


 


 


 

12


Table of Contents
     Total Assets at

   Total Deposits at

Period-end Balance Sheet Data

(in millions)


   June 30,
2004


   December 31,
2003


   June 30,
2003


   June 30,
2004


   December 31,
2003


   June 30,
2003


Regional Banking

   $ 16,526    $ 14,971    $ 14,585    $ 16,435    $ 15,539    $ 16,628

Dealer Sales

     6,162      7,335      6,607      71      77      67

PFG

     1,540      1,461      1,328      1,016      1,164      1,027

Treasury / Other

     7,193      6,752      5,817      1,943      1,707      649
    

  

  

  

  

  

Total

   $ 31,421    $ 30,519    $ 28,337    $ 19,465    $ 18,487    $ 18,371
    

  

  

  

  

  

 

Note 9 – Comprehensive Income

 

The components of Huntington’s Other Comprehensive Income in the three and six months ended June 30 were as follows:

 

    

Three Months Ended

June 30,


   

Six Months Ended

June 30,


 

(in thousands)


   2004

    2003

    2004

    2003

 

Unrealized holding (losses) gains on securities available for sale arising during the period:

                                

Unrealized net (losses) gains

     (136,458 )     9,046       (74,755 )     1,799  

Related tax benefit (expense)

     47,760       (3,162 )     26,399       (935 )
    


 


 


 


Net

     (88,698 )     5,884       (48,356 )     864  
    


 


 


 


Less: Reclassification adjustment for net gains (losses) included in net income:

                                

Realized net gains (losses)

     9,230       (6,887 )     (5,860 )     (8,085 )

Related tax (expense) benefit

     (3,231 )     2,410       2,051       2,830  
    


 


 


 


Net

     5,999       (4,477 )     (3,809 )     (5,255 )
    


 


 


 


Total unrealized holding (losses) gains on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income.

                                
    


 


 


 


Net

     (82,699 )     1,407       (52,165 )     (4,391 )
    


 


 


 


Unrealized gains (losses) on derivatives used in cash flow hedging relationships arising during the period:

                                

Unrealized net gains (losses)

     52,315       (23,415 )     34,282       (26,295 )

Related tax (expense) benefit

     (18,310 )     8,195       (11,999 )     9,203  
    


 


 


 


Net

     34,005       (15,220 )     22,283       (17,092 )
    


 


 


 


Total Other Comprehensive Loss

   $ (48,694 )   $ (13,813 )   $ (29,882 )   $ (21,483 )
    


 


 


 


 

13


Table of Contents

Activity in Accumulated Other Comprehensive Income for the six months ended June 30, 2004 and 2003 was as follows:

 

(in thousands)


   Minimum
pension
liability


    Unrealized gains
(losses) on
securities
available for sale


    Unrealized gains
(losses) on derivative
instruments used in
cash flow hedging
relationships


    Total

 

Balance, December 31, 2002

   $ (195 )   $ 56,856     $ 5,639     $ 62,300  

Period change

     —         (4,391 )     (17,092 )     (21,483 )
    


 


 


 


Balance, June 30, 2003

   $ (195 )   $ 52,465     $ (11,453 )   $ 40,817  
    


 


 


 


Balance, December 31, 2003

   $ (1,309 )   $ 9,429     $ (5,442 )   $ 2,678  

Period change

     —         (52,165 )     22,283       (29,882 )
    


 


 


 


Balance, June 30, 2004

   $ (1,309 )   $ (42,736 )   $ 16,841     $ (27,204 )
    


 


 


 


 

Note 10 – Earnings per Share

 

Basic earnings per share is the amount of earnings for the period available to each share of common stock outstanding during the reporting period. Diluted earnings per share is the amount of earnings available to each share of common stock outstanding during the reporting period adjusted for the potential issuance of common shares upon the exercise of stock options. The calculation of basic and diluted earnings per share for each of the three and six months ended June 30 is as follows:

 

     Three Months Ended
June 30,


  

Six Months Ended

June 30,


(in thousands, except per share amount)


   2004

   2003

   2004

   2003

Net Income

   $ 110,127    $ 96,490    $ 214,300    $ 188,220
    

  

  

  

Average common shares outstanding

     229,429      228,633      229,328      229,987

Dilutive effect of common stock equivalents

     3,230      1,939      3,459      1,697
    

  

  

  

Diluted Average Common Shares Outstanding

   $ 232,659    $ 230,572    $ 232,787    $ 231,684
    

  

  

  

Earnings Per Share

                           

Basic

   $ 0.48    $ 0.42    $ 0.93    $ 0.82

Diluted

   $ 0.47    $ 0.42    $ 0.92    $ 0.81

 

The average market price of Huntington’s common stock for the period was used in determining the dilutive effect of outstanding stock options. Common stock equivalents are computed based on the number of shares subject to stock options that have an exercise price less than the average market price of Huntington’s common stock for the period.

 

Approximately 6.8 million and 5.1 million stock options were vested and outstanding at June 30, 2004 and 2003, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares for the period and, therefore, the effect would be antidilutive. The weighted average exercise price for these options was $22.06 per share and $23.73 per share at the end of the same respective periods.

 

On July 30, 2004, Huntington entered into an agreement with the former shareholders of LeaseNet, Inc. to issue in early 2005 up to 86,118 shares of Huntington common stock previously held in escrow subject to LeaseNet meeting certain contractual performance criteria. A total of 366,576 common shares, previously held in escrow, will be returned to Huntington. All shares in escrow had been accounted for as treasury stock.

 

14


Table of Contents

Note 11 – Stock-Based Compensation

 

Huntington’s stock-based compensation plans are accounted for based on the intrinsic value method promulgated by APB Opinion 25, Accounting for Stock Issued to Employees, and related interpretations. Compensation expense for employee stock options is generally not recognized if the exercise price of the option equals or exceeds the fair value of the stock on the date of grant.

 

The following pro forma disclosures for net income and earnings per diluted common share is presented as if Huntington had applied the fair value method of accounting of Statement No. 123 in measuring compensation costs for stock options. The fair values of the stock options granted were estimated using the Black-Scholes option-pricing model. This model assumes that the estimated fair value of the options is amortized over the options’ vesting periods and the compensation costs would be included in personnel expense on the income statement. The following table also includes the weighted-average assumptions that were used in the option-pricing model for options granted in each of the quarters presented:

 

    

Three Months Ended

June 30,


    Six Months Ended
June 30,


 
     2004

    2003

    2004

    2003

 

Stock Options Outstanding at period end (in thousands)

     19,252       17,399       19,252       17,399  

Assumptions

                                

Risk-free interest rate

     3.89 %     4.46 %     3.82 %     4.30 %

Expected dividend yield

     3.33 %     3.26 %     3.28 %     3.30 %

Expected volatility of Huntington’s common stock

     30.9 %     33.8 %     30.9 %     33.8 %

Pro Forma Results (in millions of dollars)

                                

Net income, as reported

   $ 110.1     $ 96.5     $ 214.3     $ 188.2  

Less pro forma expense, net of tax, related to options granted

     3.1       2.9       6.4       5.9  
    


 


 


 


Pro Forma Net Income

   $ 107.0     $ 93.6     $ 207.9     $ 182.3  
    


 


 


 


Net Income Per Common Share:

                                

Basic, as reported

   $ 0.48     $ 0.42     $ 0.93     $ 0.82  

Basic, pro forma

   $ 0.47     $ 0.41     $ 0.91     $ 0.79  

Diluted, as reported

   $ 0.47     $ 0.42     $ 0.92     $ 0.81  

Diluted, pro forma

   $ 0.46     $ 0.41     $ 0.89     $ 0.79  

 

Note 12 – Restructuring Reserves

 

On a quarterly basis, Huntington assesses its remaining restructuring reserves and makes adjustments to those reserves as necessary. Huntington had remaining reserves for restructuring of $8.3 million, $9.7 million, and $9.4 million as of June 30, 2004, December 31, 2003, and June 30, 2003, respectively. Huntington expects that the reserves will be adequate to fund the estimated future cash outlays.

 

Note 13 – Benefit Plans

 

Huntington sponsors the Huntington Bancshares Retirement Plan (the Plan), a non-contributory defined benefit pension plan covering substantially all employees. The Plan provides benefits based upon length of service and compensation levels. The funding policy of Huntington is to contribute an annual amount that is at least equal to the minimum funding requirements but not more than that deductible under the Internal Revenue Code. In addition, Huntington has an unfunded defined benefit post-retirement plan that provides certain healthcare and life insurance benefits to retired employees who have attained the age of 55 and have at least 10 years of vesting service under this plan. For any employee retiring on or after January 1, 1993, post-retirement healthcare benefits are based upon the employee’s number of months of service and are limited to the actual cost of coverage. Life insurance benefits are a percentage of the employee’s base salary at the time of retirement, with a maximum of $50,000 of coverage.

 

15


Table of Contents

The following table shows the components of net periodic benefit expense:

 

    

Pension Benefits

Three Months Ended

June 30,


    Post Retirement Benefits
Three Months Ended
June 30,


(in thousands)


   2004

    2003

    2004

   2003

Service cost

   $ 3,040     $ 2,454     $ 326    $ 280

Interest cost

     4,371       4,162       802      870

Expected return on plan assets

     (5,383 )     (6,285 )     —        —  

Amortization of transition asset

     —         (63 )     276      276

Amortization of prior service cost

     —         —         146      151

Settlements

     1,000       1,089       —        —  

Recognized net actuarial loss

     1,984       444       —        —  
    


 


 

  

Benefit Expense

   $ 5,012     $ 1,801     $ 1,550    $ 1,577
    


 


 

  

 

    

Pension Benefits

Six Months Ended

June 30,


    Post Retirement Benefits
Six Months Ended
June 30,


(in thousands)


   2004

    2003

    2004

   2003

Service cost

   $ 6,078     $ 4,909     $ 650    $ 561

Interest cost

     8,741       8,323       1,604      1,739

Expected return on plan assets

     (10,764 )     (12,568 )     —        —  

Amortization of transition asset

     —         (126 )     552      551

Amortization of prior service cost

     —         —         291      303

Settlements

     2,000       2,176       —        —  

Recognized net actuarial loss

     3,968       886       —        —  
    


 


 

  

Benefit Expense

   $ 10,023     $ 3,600     $ 3,097    $ 3,154
    


 


 

  

 

Huntington also sponsors other retirement plans. One of those plans is an unfunded Supplemental Executive Retirement Plan. This plan is a nonqualified plan that provides certain former officers of Huntington and its subsidiaries with defined pension benefits in excess of limits imposed by federal tax law. Other plans, including plans assumed in various past acquisitions, are unfunded, nonqualified plans that provide certain active and former officers of Huntington and its subsidiaries nominated by Huntington’s compensation committee with deferred compensation, post-employment, and/or defined pension benefits in excess of the qualified plan limits imposed by federal tax law.

 

Huntington has a 401(k) plan, which is a defined contribution plan that is available to eligible employees. Matching contributions by Huntington equal 100% on the first 3%, then 50% on the next 2%, of participant elective deferrals. The cost of providing this plan was $2.3 million and $2.1 million for the three months ended June 30, 2004 and 2003, respectively. For the respective six-month periods, the cost was $4.7 million and $4.3 million.

 

16


Table of Contents

Note 14 – Commitments and Contingent Liabilities

 

In the ordinary course of business, Huntington makes various commitments to extend credit that are not reflected in the financial statements. The contract amount of these financial agreements at June 30, 2004, December 31, 2003, and June 30, 2003, were as follows:

 

(in millions)


   June 30,
2004


   December 31,
2003


   June 30,
2003


Contract amount represents credit risk

                    

Commitments to extend credit

                    

Commercial

   $ 4,993    $ 5,712    $ 4,924

Consumer

     3,868      3,652      3,157

Commercial real estate

     586      952      891

Standby letters of credit

     962      983      978

Commercial letters of credit

     231      166      215

 

Commitments to extend credit:

 

Commitments to extend credit generally have fixed expiration dates, are variable-rate, and contain clauses that permit Huntington to terminate or otherwise renegotiate the contracts in the event of a significant deterioration in the customer’s credit quality. These arrangements normally require the payment of a fee by the customer, the pricing of which is based on prevailing market conditions, credit quality, probability of funding, and other relevant factors. Since many of these commitments are expected to expire without being drawn upon, the contract amounts are not necessarily indicative of future cash requirements. The interest rate risk arising from these financial instruments is insignificant as a result of their predominantly short-term, variable-rate nature.

 

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. Most of these arrangements mature within two years. The carrying amount of deferred revenue associated with these guarantees was $3.2 million, $3.8 million, and $3.3 million at June 30, 2004, December 31, 2003, and June 30, 2003, respectively.

 

Commercial letters of credit represent short-term, self-liquidating instruments that facilitate customer trade transactions and generally have maturities of no longer than 90 days. The merchandise or cargo being traded normally secures these instruments.

 

Litigation:

 

In the ordinary course of business, there are various legal proceedings pending against Huntington and its subsidiaries. In the opinion of management, the aggregate liabilities, if any, arising from such proceedings are not expected to have a material adverse effect on Huntington’s consolidated financial position. (See also Note 3.)

 

17


Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

INTRODUCTION

 

Huntington Bancshares Incorporated (Huntington or the company) is a multi-state diversified financial holding company organized under Maryland law in 1966 and headquartered in Columbus, Ohio. Through its subsidiaries, Huntington is engaged in providing full-service commercial and consumer banking services, mortgage banking services, automobile financing, equipment leasing, investment management, trust services, and discount brokerage services, as well as reinsuring credit life and disability insurance, and selling other insurance and financial products and services. Huntington’s banking offices are located in Ohio, Michigan, West Virginia, Indiana, and Kentucky. Selected financial services are also conducted in other states including Arizona, Florida, Georgia, Maryland, New Jersey, Pennsylvania, and Tennessee. Huntington has a foreign office in the Cayman Islands and a foreign office in Hong Kong. The Huntington National Bank (the Bank), organized in 1866, is Huntington’s only bank subsidiary.

 

The following discussion and analysis provides investors and others with information that Management believes to be necessary for an understanding of Huntington’s financial condition, changes in financial condition, results of operations, and cash flows, and should be read in conjunction with the financial statements, notes, and other information contained in this report.

 

Forward-Looking Statements

 

This report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements about Huntington. These include descriptions of products or services, plans or objectives of Management for future operations, including pending acquisitions, and forecasts of 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 below and under the heading “Business Risks” included in Item 1 of Huntington’s Annual Report on Form 10-K for the year ended December 31, 2003 (2003 Form 10-K), and other factors described in this report and from time to time in other filings with the Securities and Exchange Commission.

 

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. Huntington assumes no obligation to 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.

 

Risk Factors

 

Huntington, like other financial companies, 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. Among the risks assumed are: (1) credit risk, which is the risk that loan and lease customers or other counter parties will be unable to perform their contractual obligations, (2) market risk, which is the risk that changes in market rates and prices will adversely affect Huntington’s financial condition or results of operations, (3) liquidity risk, which is the risk that Huntington and / or the Bank will have insufficient cash or access to cash to meet operating needs, and (4) operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people, or systems, or external events. The description of Huntington’s business contained in Item 1 of its 2003 Form 10-K, while not all inclusive, discusses a number of business risks that, in addition to the other information in this report, readers should carefully consider.

 

Securities and Exchange Commission Investigation

 

As previously disclosed, the Securities and Exchange Commission (SEC) is conducting a formal investigation regarding certain financial accounting and disclosure matters, including certain matters that were the subject of prior restatements by Huntington. The SEC staff has notified Huntington that the staff is considering recommending to the SEC that it institute enforcement action against Huntington and certain of its senior officers for, among other possible matters, violations of various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933 in connection with certain financial accounting matters relating to fiscal years 2002 and earlier, and certain related disclosure matters.

 

Huntington is presently in negotiations with the staff of the SEC regarding a settlement of its investigation. Huntington’s chief executive officer has indicated he accepts responsibility in his position as the chief executive officer for matters that occur on his watch, and has indicated a willingness to negotiate a settlement with the SEC of these matters. Huntington expects that a settlement of this matter would involve the entry of an order requiring, among other possible matters, Huntington to comply with various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933, along with the imposition of a fine and other possible measures. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.

 

Huntington also remains in active dialogue with its bank regulators concerning these matters and is working diligently with the regulators to resolve them in a manner that permits it to proceed with its pending Unizan acquisition. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.

 

Donald R. Kimble, who joined Huntington earlier this year as executive vice president in the Finance area, has been named chief financial officer and controller. Prior to joining Huntington, Kimble was executive vice president and controller of AmSouth Bancorporation, and previously held various subsidiary chief financial officer or accounting positions at Bank One Corporation. Michael J. McMennamin and John D. Van Fleet have relinquished their positions of chief financial officer and controller, respectively. Both remain with the company.

 

18


Table of Contents

Critical Accounting Policies and Use of Significant Estimates

 

Note 1 to the company’s Notes to Consolidated Financial Statements included in Huntington’s 2003 Form 10-K lists significant accounting policies used in the development and presentation of its financial statements. These significant accounting policies, as well as the following discussion and analysis 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 Huntington, its financial position, results of operations, and cash flows.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires Huntington’s 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 of Huntington if a different amount within a range of estimates were used or if estimates changed from period to period. Readers of this interim 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. Huntington’s management has identified the most significant accounting estimates and their related application in Huntington’s 2003 Form 10-K.

 

SUMMARY DISCUSSION OF RESULTS

 

Earnings comparisons from the second quarter of 2003 through the second quarter of 2004 were impacted by a number of factors, some related to changes in the economic and competitive environment, while others reflected specific Management strategies or changes in accounting practices. Understanding the nature and implications of these factors on financial results is important in understanding the company’s income statement, balance sheet, and credit quality trends and the comparison of the current quarter and year-to-date performance with comparable prior-year periods. The key factors impacting the current reporting period comparisons are more fully described in the Significant Factors Influencing Financial Performance Comparisons section, which follows the summary of results below.

 

2004 Second Quarter versus 2003 Second Quarter

 

Huntington’s 2004 second quarter earnings were $110.1 million, or $0.47 per common share, up 14% and 12%, respectively, from $96.5 million and $0.42 per common share in the year-ago quarter. This increase in earnings reflected:

 

  90% decrease in provision for credit losses,

 

  10% increase in fully taxable equivalent net interest income, and

 

  5% decline in non-interest expenses

 

Partially offset by a 21% decline in non-interest income.

 

The return on average assets (ROA) and return on average equity (ROE), were 1.41% and 19.1%, respectively, compared with 1.38% and 18.0% in the year-ago quarter (see Table 1).

 

2004 Second Quarter versus 2004 First Quarter

 

Compared with 2004 first quarter net income of $104.2 million, or $0.45 per common share, 2004 second quarter earnings were up 6% and 4%, respectively. This increase in earnings primarily reflected:

 

  80% decline in provision for credit losses, and

 

  1% decline in non-interest expenses

 

Partially offset by a 4% decline in non-interest income.

 

The ROA and ROE were 1.41% and 19.1%, respectively, in the current quarter, compared with 1.36% and 18.4% in the 2004 first quarter (see Table 1).

 

19


Table of Contents

Table 1 - Selected Quarterly Income Statement Data

 

(in thousands, except per share amounts)


   2004

    2003

    2Q04 vs. 2Q03

 
   Second

    First

    Fourth

    Third

    Second

    Amount

    %

 

Total interest income

   $ 324,167     $ 325,931     $ 335,097     $ 333,320     $ 317,325     $ 6,842     2.2 %

Total interest expense

     101,604       103,246       110,782       112,849       114,884       (13,280 )   (11.6 )%
    


 


 


 


 


 


 

Net interest income

     222,563       222,685       224,315       220,471       202,441       20,122     9.9 %

Provision for credit losses

     5,027       25,596       26,341       51,615       49,193       (44,166 )   (89.8 )%
    


 


 


 


 


 


 

Net interest income after provision for credit losses

     217,536       197,089       197,974       168,856       153,248       64,288     42.0 %
    


 


 


 


 


 


 

Operating lease income

     78,706       88,867       105,307       117,624       128,574       (49,868 )   (38.8 )%

Service charges on deposit accounts

     43,596       41,837       44,763       42,294       40,914       2,682     6.6 %

Trust services

     16,708       16,323       15,793       15,365       15,580       1,128     7.2 %

Brokerage and insurance

     13,523       15,197       14,344       13,807       14,196       (673 )   (4.7 )%

Mortgage banking

     23,322       (4,296 )     9,677       30,193       7,185       16,137     N.M.  

Bank owned life insurance

     11,309       10,485       10,410       10,438       11,043       266     2.4 %

Gain on sale of automobile loans

     4,890       9,004       16,288       —         13,496       (8,606 )   (63.8 )%

Gain on sale of branch office

     —         —         —         13,112       —         —       N.M.  

Other service charges and fees

     10,645       9,513       9,237       10,499       11,372       (727 )   (6.4 )%

Securities gains (losses)

     (9,230 )     15,090       1,280       (4,107 )     6,887       (16,117 )   N.M.  

Other

     24,659       25,619       19,411       23,543       27,704       (3,045 )   (11.0 )%
    


 


 


 


 


 


 

Total non-interest income

     218,128       227,639       246,510       272,768       276,951       (58,823 )   (21.2 )%
    


 


 


 


 


 


 

Personnel costs

     119,715       121,624       115,762       113,170       105,242       14,473     13.8 %

Operating lease expense

     62,563       70,710       85,609       93,134       102,939       (40,376 )   (39.2 )%

Outside data processing and other services

     17,563       18,462       15,957       17,478       16,104       1,459     9.1 %

Equipment

     16,228       16,086       16,840       16,328       16,341       (113 )   (0.7 )%

Net occupancy

     16,258       16,763       14,925       15,570       15,377       881     5.7 %

Professional services

     7,836       7,299       12,175       11,116       9,872       (2,036 )   (20.6 )%

Marketing

     8,069       7,839       6,895       5,515       8,454       (385 )   (4.6 )%

Telecommunications

     4,638       5,194       5,272       5,612       5,394       (756 )   (14.0 )%

Printing and supplies

     3,098       3,016       3,417       3,658       2,253       845     37.5 %

Amortization of intangibles

     204       204       204       204       204       —       N.M.  

Loss on early extinguishment of debt

     —         —         15,250       —         —         —       N.M.  

Restructuring reserve releases

     —         —         (351 )     —         (5,315 )     5,315     N.M.  

Other

     25,981       18,457       25,510       18,397       20,168       5,813     28.8 %
    


 


 


 


 


 


 

Total non-interest expense

     282,153       285,654       317,465       300,182       297,033       (14,880 )   (5.0 )%
    


 


 


 


 


 


 

Income before provision for income taxes

     153,511       139,074       127,019       141,442       133,166       20,345     15.3 %

Provision for income taxes

     43,384       34,901       33,758       37,230       36,676       6,708     18.3 %
    


 


 


 


 


 


 

Income before cumulative effect effect of change in accounting principle

     110,127       104,173       93,261       104,212       96,490       13,637     14.1 %

Cumulative effect of change in accounting principle, net of tax (1)

     —         —         —         (13,330 )     —         —       N.M.  
    


 


 


 


 


 


 

Net Income

   $ 110,127     $ 104,173     $ 93,261     $ 90,882     $ 96,490     $ 13,637     14.1 %
    


 


 


 


 


 


 

Per Common Share

                                                      

Income before cumulative effect of change in accounting

                                                      

principle - Diluted

   $ 0.47     $ 0.45     $ 0.40     $ 0.45     $ 0.42     $ 0.05     11.9 %

Net income - Diluted

     0.47       0.45       0.40       0.39       0.42       0.05     11.9 %

Cash dividends declared

     0.175       0.175       0.175       0.175       0.16       0.02     9.4 %

Return on:

                                                      

Average total assets (2)

     1.41 %     1.36 %     1.22 %     1.38 %     1.38 %     0.03 %   2.2 %

Average total shareholders’ equity (2)

     19.1 %     18.4 %     16.6 %     18.5 %     18.0 %     1.1 %   6.1 %

Net interest margin (3)

     3.29 %     3.36 %     3.42 %     3.46 %     3.47 %     (0.18 )%   (5.2 )%

Efficiency ratio (4)

     62.3 %     65.1 %     67.1 %     60.0 %     62.5 %     (0.2 )%   (0.3 )%

Effective tax rate

     28.3 %     25.1 %     26.6 %     26.3 %     27.5 %     0.8 %   2.9 %

Revenue - Fully Taxable Equivalent (FTE)

                                                      

Net interest income

   $ 222,563     $ 222,685     $ 224,315     $ 220,471     $ 202,441     $ 20,122     9.9 %

Tax equivalent adjustment (3)

     2,919       3,023       2,954       2,558       2,076       843     40.6 %
    


 


 


 


 


 


 

Net Interest Income

     225,482       225,708       227,269       223,029       204,517       20,965     10.3 %

Non-Interest Income

     218,128       227,639       246,510       272,768       276,951       (58,823 )   (21.2 )%
    


 


 


 


 


 


 

Total Revenue

   $ 443,610     $ 453,347     $ 473,779     $ 495,797     $ 481,468     $ (37,858 )   (7.9 )%
    


 


 


 


 


 


 


(1) Due to the adoption of FASB Interpretation No. 46 for variable interest entities.
(2) Based on income before cumulative effect change in accounting principle, net of tax.
(3) On a fully taxable equivalent (FTE) basis assuming a 35% tax rate.
(4) Non-interest expense less amortization of intangibles divided by the sum of FTE net interest income and non-interest income excluding securities gains (losses).
N.M. - Not Meaningful

 

20


Table of Contents

Table 2 - Selected Year to Date Income Statement Data

 

    

Six Months Ending

June 30,


    2004 vs. 2003

 

(in thousands, except per share amounts)


   2004

    2003

    Amount

    %

 

Total interest income

   $ 650,098     $ 637,339     $ 12,759     2.0 %

Total interest expense

     204,850       233,139       (28,289 )   (12.1 )%
    


 


 


 

Net interest income

     445,248       404,200       41,048     10.2 %

Provision for credit losses

     30,623       86,037       (55,414 )   (64.4 )%
    


 


 


 

Net interest income after provision for credit losses

     414,625       318,163       96,462     30.3 %
    


 


 


 

Operating lease income

     167,573       266,767       (99,194 )   (37.2 )%

Service charges on deposit accounts

     85,433       80,783       4,650     5.8 %

Trust services

     33,031       30,491       2,540     8.3 %

Brokerage and insurance

     28,720       29,693       (973 )   (3.3 )%

Mortgage banking

     19,026       18,310       716     3.9 %

Bank owned life insurance

     21,794       22,180       (386 )   (1.7 )%

Gain on sale of automobile loans

     13,894       23,751       (9,857 )   (41.5 )%

Other service charges and fees

     20,158       21,710       (1,552 )   (7.1 )%

Securities gains

     5,860       8,085       (2,225 )   (27.5 )%

Other

     50,278       48,105       2,173     4.5 %
    


 


 


 

Total non-interest income

     445,767       549,875       (104,108 )   (18.9 )%
    


 


 


 

Personnel costs

     241,339       218,331       23,008     10.5 %

Operating lease expense

     133,273       214,527       (81,254 )   (37.9 )%

Outside data processing and other services

     36,025       32,683       3,342     10.2 %

Equipment

     32,314       32,753       (439 )   (1.3 )%

Net occupancy

     33,021       31,986       1,035     3.2 %

Professional services

     15,135       19,157       (4,022 )   (21.0 )%

Marketing

     15,908       15,080       828     5.5 %

Telecommunications

     9,832       11,095       (1,263 )   (11.4 )%

Printing and supplies

     6,114       5,934       180     3.0 %

Amortization of intangibles

     408       408       —       N.M.  

Restructuring reserve releases

     —         (6,315 )     6,315     N.M.  

Other

     44,438       36,873       7,565     20.5 %
    


 


 


 

Total non-interest expense

     567,807       612,512       (44,705 )   (7.3 )%
    


 


 


 

Income before provision for income taxes

     292,585       255,526       37,059     14.5 %

Provision for income taxes

     78,285       67,306       10,979     16.3 %
    


 


 


 

Net Income

   $ 214,300     $ 188,220     $ 26,080     13.9 %
    


 


 


 

Per Common Share

                              

Net income - Diluted

   $ 0.92     $ 0.81     $ 0.11     13.6 %

Cash dividends declared

   $ 0.35     $ 0.32     $ 0.03     9.4 %

Return on:

                              

Average total assets

     1.36 %     1.35 %     0.01 %   0.8 %

Average total shareholders’ equity

     18.4 %     17.3 %     1.1 %   6.1 %

Net interest margin (1)

     3.32 %     3.52 %     (0.20 )%   (5.7 )%

Efficiency ratio (2)

     63.7 %     64.4 %     (0.7 )%   (1.1 )%

Effective tax rate

     26.8 %     26.3 %     0.5 %   1.7 %

Revenue - Fully Taxable Equivalent (FTE)

                              

Net interest income

   $ 445,248     $ 404,200     $ 41,048     10.2 %

Tax equivalent adjustment (1)

     5,942       4,172       1,770     42.4 %
    


 


 


 

Net Interest Income

     451,190       408,372       42,818     10.5 %

Non-Interest Income

     445,767       549,875       (104,108 )   (18.9 )%
    


 


 


 

Total Revenue

   $ 896,957     $ 958,247     $ (61,290 )   (6.4 )%
    


 


 


 


(1) On a fully taxable equivalent (FTE) basis assuming a 35% tax rate.
(2) Non-interest expense less amortization of intangibles divided by the sum of FTE net interest income and non-interest income excluding securities gains.

 

21


Table of Contents

2004 First Six Months versus 2003 First Six Months

 

Earnings for the first six months of 2004 were $214.3 million, or $0.92 per common share, both up 14% from the comparable year-ago period earnings of $188.2 million, or $0.81 per common share. This increase in earnings reflected:

 

  64% decrease in provision for credit losses,

 

  10% increase in fully taxable equivalent net interest income, and

 

  7% decline in non-interest expenses

 

Partially offset by a 19% decline in non-interest income.

 

The ROA and ROE were 1.36% and 18.4%, respectively, compared with 1.35% and 17.3% in the year-ago six-month period (see Table 2).

 

Significant Factors Influencing Financial Performance Comparisons

 

Earnings comparisons from the second quarter of 2003 through the second quarter of 2004 were impacted by a number of factors, some related to changes in the economic and competitive environment, while others reflected specific Management strategies or changes in accounting practices. Those key factors are summarized below.

 

  1. Automobile leases originated through April 2002 accounted for as operating leases – Automobile leases originated before May 2002 are accounted for using the operating lease method of accounting because they do not qualify as direct financing leases. Operating leases are a non-interest earning asset with the related rental income, other revenue, and credit recoveries reflected as operating lease income, a component of non-interest income. Under this accounting method, depreciation expenses, as well as other costs and charge-offs, are reflected as operating lease expense, a component of non-interest expense. With no new operating leases originated since April 2002, the operating lease assets are rapidly decreasing and will eventually run-off, along with related operating lease income and expense. Since operating lease income and expense represent a significant percentage of total non-interest income and expense, respectively, throughout this reporting period, their downward trend influences total non-interest income and non-interest expense trends.

 

       All automobile leases originated since April 2002 are accounted for as direct financing leases, an interest earning asset included in total loans and leases with the related income reflected as interest income and included in the calculation of the net interest margin. Credit charge-offs and recoveries are reflected in the allowance for loan and lease losses (ALLL), with related changes in the ALLL reflected in provision for credit losses. The relative newness and rapid growth of this portfolio has resulted in higher reported automobile lease growth rates than in a more mature portfolio. To better understand overall trends in automobile lease exposure it is helpful to compare trends of the combined total of automobile leases plus operating leases (see the company’s 2003 Form 10-K for a full discussion).

 

  2. Transition from a weak economic environment in 2003 to a recovering economic environment in 2004. The weak economic environment resulted in significant reductions in non-performing assets (NPAs), charge-offs, and the ALLL, as well as continued weak demand for commercial and industrial (C&I) loans, which contributed to declining C&I loans through the first quarter of 2004.

 

  3. Declining interest rates in 2003 with generally increasing interest rates in 2004. Interest rates impacted, among other factors, loan and deposit growth, the net interest margin, and the valuation of mortgage servicing rights (MSRs) and investment securities.

 

  The historically low interest rate environment resulted in strong demand and resultant growth in residential real estate, home equity, and commercial real estate (CRE) loans generally throughout this period. Mortgage banking revenue was also favorably impacted by the significant mortgage origination activity.

 

22


Table of Contents
  As interest rates fell in 2003 and attained historically low absolute levels, it became increasingly difficult to lower interest rates offered on deposit accounts commensurate with the overall decline in interest rates and yields on earning assets. This created an extremely competitive environment in which to grow deposits. These factors resulted in an inability to lower deposit rates commensurate with the overall decline in earning asset rates, which contributed to the decline in the net interest margin throughout this period.

 

  Since the second quarter of 2002, the company generally has retained the servicing on mortgage loans it originates and sells. The mortgage servicing right, or MSR, represents the present value of expected future net servicing income for the loan. MSR values are very sensitive to movements in interest rates. Expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly affected by prepayments. Prepayments usually increase when interest rates decline and decrease when interest rates rise. Thus, as interest rates decline, less future income is expected and the value of MSRs declines and becomes impaired when the valuation is less than the recorded book value. The company recognizes temporary impairment due to change in interest rates through a valuation reserve and records a direct write-down of the book value of its MSRs for other-than-temporary declines in valuation. Changes in interest rate levels between quarters resulted in some quarters reporting an MSR temporary impairment, with others reporting a recovery of previously reported MSR temporary impairment. Such swings in MSR valuations have significantly impacted quarterly mortgage banking income throughout this period (see Table 3).

 

  The company uses gains or losses on investment securities to offset MSR temporary valuation changes. As a result, changes in interest rate levels have also resulted in securities gains or losses. As such, in quarters where an MSR temporary impairment is recognized, investment securities were sold resulting in a gain on sale, and vice versa. The earnings impact of the MSR valuation change and securities gain/loss may not exactly offset due to, among other factors, the difference in the timing of when the MSR valuation is determined and recorded, compared with when the securities are sold and any gain or loss is recorded (see Table 3).

 

  4. Management strategies to lower the overall credit risk profile of the balance sheet. Throughout this period, certain strategies were implemented to lower the overall credit risk profile of the balance sheet with the objective of lowering the volatility of earnings.

 

  Automobile loan sales – One strategy has been to lower the credit exposure to automobile loans and leases to 20% of total credit exposure, as manifested through the sale of automobile loans. These sales of higher-rate, higher-risk loans impact results in a number of ways including: lower growth rates in automobile, total consumer, and total company loans; the generation of gains reflected in non-interest income; lower net interest income than otherwise would be the case if the loans were not sold; and lower net interest margin (see Table 3).

 

  Reduction in large-individual C&I and CRE credits – This strategy has been reflected in the reduction in shared national credits, as well as other, mostly C&I, loans. In addition, the company sold and charged-off lower-quality C&I and CRE credits in 2003 and 2004. This strategy was a contributing factor in the declines in C&I loan balances, NPAs, and the ALLL. In certain quarters, this strategy contributed to higher C&I net charge-offs.

 

  5. Adoption of FIN 46 – Effective July 1, 2003, the company adopted Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. The adoption of FIN 46 resulted in the consolidation of $1.0 billion of previously securitized automobile loans and a $13.3 million after-tax charge in the 2003 third quarter for the cumulative effect of a change in accounting principle (see Tables 1 and 2).

 

  6. Corporate Restructuring Charges – The 2001 strategic refocusing plan included the intent to sell the Florida banking and insurance operations, credit-related and other actions to strengthen the balance sheet and financial performance, and the consolidation of numerous non-Florida banking offices. As a result, non-interest expenses in 2001 and 2002 were higher than they otherwise would have been as they included net restructuring charges based on estimated costs associated with implementing these strategic initiatives. In contrast, 2003 non-interest expense reflected recoveries of previously established reserves, which were no longer needed (see Table 3) and lowered 2003 non-interest expense (see Note 21 of the company’s 2003 Form 10-K Notes to Consolidated Financial Statements). There were no increases or releases of restructuring charges in the first half of 2004.

 

23


Table of Contents
  7. Single commercial recovery – A single commercial credit recovery in the 2004 second quarter on a loan previously charged off in the 2002 fourth quarter favorably impacted the 2004 second quarter provision expense (see Table 3), as well as C&I, total commercial, and total net charge-offs for the quarter (see Table 11).

 

The following table quantifies the earnings impact of changes in MSR and investment securities valuation, sales of automobile loans, restructuring reserve releases, and a single, large commercial credit recovery on the specified periods.

 

Table 3 - Significant Items Influencing Earnings Performance Comparisons

 

(in millions, except per share )


  

Pre-tax


   

Impact

After-tax (1)


   

EPS


 
      

Three Months Ended:

                        

June 30, 2004 - GAAP earnings

   $ 153.5     $ 110.1     $ 0.47  

Gain on sale of automobile loans

     4.9       3.2       0.01  

Mortgage servicing right (MSR) temporary impairment recovery

     10.4       6.8       0.03  

Investment securities losses

     (9.2 )     (6.0 )     (0.03 )

Single commercial credit recovery

     9.7       6.3       0.03  

June 30, 2003 - GAAP earnings

   $ 133.2     $ 96.5     $ 0.42  

Gain on sale of automobile loans

     13.5       8.8       0.04  

MSR temporary impairment

     (6.4 )     (4.1 )     (0.02 )

Investment securities gains

     6.9       4.5       0.02  

Restructuring reserve releases

     5.3       3.5       0.01  

Six Months Ended:

                        

June 30, 2004 - GAAP earnings

   $ 292.6     $ 214.3     $ 0.92  

Gain on sale of automobile loans

     13.9       9.0       0.04  

MSR temporary impairment recovery

     0.3       0.2       —    

Investment securities gain on sale

     5.9       4.0       0.02  

Single commercial credit recovery

     9.7       6.3       0.03  

June 30, 2003 - GAAP earnings

   $ 255.5     $ 188.2     $ 0.81  

Gain on sale of automobile loans

     23.8       15.0       0.06  

MSR temporary impairment

     (6.4 )     (4.1 )     (0.02 )

Investment securities gains

     8.1       5.0       0.02  

Restructuring reserve releases

     6.3       4.0       0.02  

(1) Increase (decrease) to GAAP earnings.

 

24


Table of Contents

RESULTS OF OPERATIONS

 

Net Interest Income

 

2004 Second Quarter versus 2003 Second Quarter

 

Fully taxable equivalent net interest income increased $21.0 million, or 10%, from the year-ago quarter, reflecting the favorable impact of a 16% increase in average earning assets, partially offset by an 18 basis point, or an effective 5%, decline in the net interest margin. The fully taxable equivalent net interest margin decreased to 3.29% from 3.47%, reflecting the continued impact of historically low interest rates and the strategic repositioning of portfolios to reduce automobile loans and increase the relative proportion of lower-rate, and lower-risk, residential real estate-related loans and investment securities.

 

Average total loans and leases increased $2.5 billion, or 13%, from the 2003 second quarter due primarily to a $2.2 billion, or 23%, increase in average consumer loans. Contributing to the consumer loan growth was a $1.1 billion, or 58%, increase in average residential mortgages and a $0.8 billion, or 23%, increase in average home equity loans. Average total automobile loans and leases increased $0.3 billion, or 8%. This growth from the year-ago quarter reflected the positive impact of underlying new automobile loan originations, the 2003 third quarter consolidation of a $1.0 billion automobile loan securitization trust, and the rapid growth in direct financing leases due to the migration from operating lease assets, which are no longer being originated. Offsetting these positive impacts was the sale of $2.4 billion of automobile loans over this 12-month period (see Loan and Lease Composition for additional discussion and Table 10).

 

Average total C&I and CRE loans increased $0.3 billion, or 3%, from the year-ago quarter, reflecting an 11% increase in small business C&I and CRE loans and a 9% increase in middle-market CRE loans. Average middle-market C&I loans were down 4% from the year-ago period and reflected both weak demand and the impact from continued strategies to specifically lower exposure to large individual commercial credits, including shared national credits.

 

Average investment securities increased $1.6 billion, or 43%, from the year-ago quarter, primarily reflecting the investment of a portion of the proceeds from the automobile loan sales. The growth from the year-ago quarter primarily consisted of 10-year variable-rate securities.

 

Average total core deposits in the second quarter were $16.2 billion, up $0.8 billion, or 5%, from the year-ago quarter. This growth primarily reflected a $1.1 billion, or 18%, increase in interest bearing demand deposits, partially offset by a $0.4 billion, or 14%, decline in retail CDs.

 

25


Table of Contents

Tables 4 and 5 reflect quarterly average balance sheets and rates earned and paid on interest-earning assets and interest-bearing liabilities:

 

Table 4 - Condensed Consolidated Quarterly Average Balance Sheets

 

     Average Balances

   2Q04 vs. 2Q03

 

(in millions)


   2004

   2003

  

Fully Tax Equivalent Basis


   Second

   First

   Fourth

   Third

   Second

   Amount

    Percent

 

Assets

                                                 

Interest bearing deposits in banks

   $ 69    $ 79    $ 83    $ 90    $ 45    $ 24     53.3 %

Trading account securities

     28      16      11      11      22      6     27.3  

Federal funds sold and securities purchased under resale agreements

     168      92      117      103      69      99     N.M.  

Loans held for sale

     254      207      295      898      601      (347 )   (57.7 )

Securities:

                                                 

Taxable

     4,861      4,646      4,093      3,646      3,385      1,476     43.6  

Tax exempt

     410      437      424      358      291      119     40.9  
    

  

  

  

  

  


 

Total Securities

     5,271      5,083      4,517      4,004      3,676      1,595     43.4  
    

  

  

  

  

  


 

Loans and Leases:

                                                 

Commercial and industrial

     5,536      5,365      5,382      5,380      5,626      (90 )   (1.6 )

Real Estate

                                                 

Construction

     1,322      1,322      1,297      1,258      1,239      83     6.7  

Commercial

     2,906      2,876      2,830      2,744      2,621      285     10.9  

Consumer

                                                 

Automobile loans

     2,337      3,041      3,529      3,594      2,830      (493 )   (17.4 )

Automobile leases

     2,139      1,988      1,802      1,590      1,306      833     63.8  
    

  

  

  

  

  


 

Automobile loans and leases

     4,476      5,029      5,331      5,184      4,136      340     8.2  
    

  

  

  

  

  


 

Home equity

     4,142      3,880      3,678      3,503      3,359      783     23.3  

Residential mortgage

     2,986      2,674      2,501      2,075      1,887      1,099     58.2  

Other loans

     399      356      387      367      379      20     5.3  
    

  

  

  

  

  


 

Total Consumer

     12,003      11,939      11,897      11,129      9,761      2,242     23.0  
    

  

  

  

  

  


 

Total Loans and Leases

     21,767      21,502      21,406      20,511      19,247      2,520     13.1  
    

  

  

  

  

  


 

Allowance for loan and lease losses

     310      313      350      330      304      6     2.0  
    

  

  

  

  

  


 

Net loans and leases

     21,457      21,189      21,056      20,181      18,943      2,514     13.3  
    

  

  

  

  

  


 

Total earning assets

     27,557      26,979      26,429      25,617      23,660      3,897     16.5  
    

  

  

  

  

  


 

Operating lease assets

     977      1,166      1,355      1,565      1,802      (825 )   (45.8 )

Cash and due from banks

     772      740      766      747      735      37     5.0  

Intangible assets

     216      217      217      218      218      (2 )   (0.9 )

All other assets

     2,101      2,046      2,005      2,067      1,988      113     5.7  
    

  

  

  

  

  


 

Total Assets

   $ 31,313    $ 30,835    $ 30,422    $ 29,884    $ 28,099    $ 3,214     11.4 %
    

  

  

  

  

  


 

Liabilities and Shareholders’ Equity

                                                 

Core deposits

                                                 

Non-interest bearing deposits

   $ 3,223    $ 3,017    $ 3,131    $ 3,218    $ 3,046    $ 177     5.8 %

Interest bearing demand deposits

     7,168      6,609      6,466      6,558      6,100      1,068     17.5  

Savings deposits

     2,839      2,819      2,824      2,808      2,804      35     1.2  

Retail certificates of deposit

     2,400      2,399      2,492      2,561      2,798      (398 )   (14.2 )

Other domestic time deposits

     600      637      631      656      673      (73 )   (10.8 )
    

  

  

  

  

  


 

Total core deposits

     16,230      15,481      15,544      15,801      15,421      809     5.2  
    

  

  

  

  

  


 

Domestic time deposits of $100,000 or more

     795      788      828      803      808      (13 )   (1.6 )

Brokered time deposits and negotiable CDs

     1,737      1,907      1,851      1,421      1,241      496     40.0  

Foreign time deposits

     542      549      522      536      426      116     27.2  
    

  

  

  

  

  


 

Total deposits

     19,304      18,725      18,745      18,561      17,896      1,408     7.9  
    

  

  

  

  

  


 

Short-term borrowings

     1,396      1,603      1,433      1,393      1,635      (239 )   (14.6 )

Federal Home Loan Bank advances

     1,270      1,273      1,273      1,273      1,267      3     0.2  

Subordinated notes and other long-term debt,

                                                 

including preferred capital securities

     5,623      5,557      5,432      5,197      4,010      1,613     40.2  
    

  

  

  

  

  


 

Total interest bearing liabilities

     24,370      24,141      23,752      23,206      21,762      2,608     12.0  
    

  

  

  

  

  


 

All other liabilities

     1,397      1,399      1,311      1,221      1,140      257     22.5  

Shareholders’ equity

     2,323      2,278      2,228      2,239      2,151      172     8.0  
    

  

  

  

  

  


 

Total Liabilities and Shareholders’ Equity

   $ 31,313    $ 30,835    $ 30,422    $ 29,884    $ 28,099    $ 3,214     11.4 %
    

  

  

  

  

  


 

 

26


Table of Contents

Table 5 - Condensed Consolidated Quarterly Net Interest Margin Analysis

 

     Average Rates (2)

 

(in millions)


   2004

    2003

 

Fully Tax Equivalent Basis (1)


   Second

    First

    Fourth

    Third

    Second

 

Assets

                              

Interest bearing deposits in banks

   1.07 %   0.71 %   0.60 %   0.51 %   1.58 %

Trading account securities

   3.02     3.98     2.39     4.70     4.15  

Federal funds sold and securities purchased under resale agreements

   1.21     1.41     1.30     1.92     2.19  

Loans held for sale

   5.17     5.33     5.31     5.16     5.42  

Securities:

                              

Taxable

   3.83     4.06     4.24     4.23     4.58  

Tax exempt

   7.07     6.88     6.91     6.93     6.91  
    

 

 

 

 

Total Securities

   4.09     4.30     4.49     4.47     4.77  
    

 

 

 

 

Loans and Leases: (2)

                              

Commercial and industrial

   4.25     4.49     4.82     4.84     5.26  

Real Estate

                              

Construction

   3.70     3.68     4.24     4.17     4.07  

Commercial

   4.57     4.70     4.99     5.22     5.28  

Consumer

                              

Automobile loans

   7.20     6.93     6.90     7.19     7.74  

Automobile leases

   5.06     4.94     4.98     4.99     4.69  
    

 

 

 

 

Automobile loans and leases

   6.17     6.14     6.25     6.51     6.78  
    

 

 

 

 

Home equity

   4.92     4.82     4.87     5.09     5.02  

Residential mortgage

   5.30     5.44     5.20     5.32     5.76  

Other loans

   7.48     7.24     7.19     7.38     7.22  
    

 

 

 

 

Total Consumer

   5.49     5.52     5.64     5.87     5.99  
    

 

 

 

 

Total Loans and Leases

   4.95     5.04     5.26     5.41     5.56  
    

 

 

 

 

Total earning assets

   4.76 %   4.89 %   5.11 %   5.23 %   5.42 %
    

 

 

 

 

Liabilities and Shareholders’ Equity

                              

Core deposits

                              

Non-interest bearing deposits

                              

Interest bearing demand deposits

   0.81 %   0.88 %   0.91 %   1.04 %   1.39 %

Savings deposits

   0.82     0.94     1.22     1.35     1.55  

Retail certificates of deposit

   3.27     3.47     3.54     3.51     3.75  

Other domestic time deposits

   3.19     3.48     3.69     3.89     3.85  
    

 

 

 

 

Total core deposits

   1.45     1.53     1.65     1.76     2.09  
    

 

 

 

 

Domestic time deposits of $100,000 or more

   2.37     2.14     2.37     2.32     2.55  

Brokered time deposits and negotiable CDs

   1.57     1.51     1.52     1.63     1.79  

Foreign time deposits

   0.76     0.72     0.75     0.85     1.03  
    

 

 

 

 

Total deposits

   1.48     1.53     1.64     1.75     2.06  
    

 

 

 

 

Short-term borrowings

   0.80     0.83     0.78     0.85     1.06  

Federal Home Loan Bank advances

   2.52     2.50     2.24     1.81     1.76  

Subordinated notes and other long-term debt, including preferred capital securities

   2.24     2.33     2.63     2.78     2.85  
    

 

 

 

 

Total interest bearing liabilities

   1.66 %   1.71 %   1.85 %   1.93 %   2.11 %
    

 

 

 

 

Net interest rate spread

   3.10 %   3.18 %   3.26 %   3.30 %   3.31 %

Impact of non-interest bearing funds on margin

   0.19     0.18     0.16     0.16     0.16  
    

 

 

 

 

Net Interest Margin

   3.29 %   3.36 %   3.42 %   3.46 %   3.47 %
    

 

 

 

 


(1) Fully tax equivalent (FTE) yields are calculated assuming a 35% tax rate. See page 20 for the fully taxable equivalent adjustment.
(2) Loan and lease and deposit average rates include impact of applicable derivatives and non-deferrable fees.

 

27


Table of Contents

2004 Second Quarter versus 2004 First Quarter

 

Compared with the 2004 first quarter, fully taxable equivalent net interest income decreased only $0.2 million, reflecting the adverse impact of automobile loan sales. The fully taxable equivalent net interest margin declined 7 basis points, or an effective 2%, to 3.29% from 3.36%. Average earnings assets, despite the negative impact from the sale of automobile loans, increased $0.6 billion, or 2%. The decline in the net interest margin from the first quarter reflected the same factors as those impacting the decrease from the year-ago quarter.

 

Average total loans and leases in the second quarter increased $0.3 billion, or 1%, from the first quarter, as the growth rate was mitigated by a $0.7 billion, or 23%, decline in average automobile loans due to the first quarter sale of $868 million of automobile loans. Growth in mortgage-related consumer loans remained strong with average residential mortgages up $0.3 billion, or 12%, and average home equity loans up $0.3 billion, or 7%. Total average C&I and CRE loans increased $0.2 billion, or 2%, reflecting a 2% increase in small business C&I and CRE loans, a 3% increase in middle-market C&I loans, and a 1% increase in middle-market CRE loans.

 

Average investment securities increased $0.2 billion, or 4%, from the first quarter, primarily reflecting the investment of a portion of the proceeds from the first quarter automobile loan sale. However, investment securities at June 30, 2004, were down $0.5 billion, or 9%, from the end of the first quarter. Average loans held for sale decreased $0.3 billion, or 58%, from the year-ago quarter.

 

Average total core deposits in the second quarter increased $0.7 billion, or 5%, reflecting strong growth in interest bearing demand deposits, up $0.6 billion, or 8%, as well as non-interest bearing deposits, up $0.2 billion, or 7%.

 

2004 First Six Months versus 2003 First Six Months

 

Fully taxable equivalent net interest income for the first six months of 2004 increased $42.8 million, or 10%, from the comparable year-ago period, reflecting the favorable impact of a 17% increase in average earning assets, partially offset by an 20 basis point, or an effective 6%, decline in the net interest margin. The fully taxable equivalent net interest margin decreased to 3.32% from 3.52%, reflecting the impact of lower rates and the strategic repositioning of portfolios to reduce automobile loans and increase the relative proportion of lower-rate, and lower-risk, residential real estate-related loans and investment securities.

 

Average total loans and leases increased $2.6 billion, or 13%, from the first six months of 2003 due primarily to a $2.3 billion, or 24%, increase in average consumer loans. Contributing to the consumer loan growth was a $1.0 billion, or 52%, increase in average residential mortgages and a $0.7 billion, or 22%, increase in average home equity loans. Average total automobile loans and leases increased $0.6 billion, or 16%. This growth from the year-ago six-month period reflected the positive impact of underlying new automobile loan originations, the 2003 third quarter consolidation of a $1.0 billion automobile loan securitization trust, and the rapid growth in direct financing leases due to the migration from operating lease assets, which are no longer being originated. Partially offsetting these positive impacts was the sale of automobile loans over this period.

 

Average total C&I and CRE loans in the first six months of 2004 increased $0.2 billion, or 2%, from the comparable year-ago period, reflecting an 11% increase in small business C&I and CRE loans and a 10% increase in middle-market CRE loans. Average middle-market C&I loans were down 5% from the year-ago period and reflected both weak demand and the impact from continued strategies to specifically lower exposure to large individual commercial credits, including shared national credits.

 

Average investment securities increased $1.7 billion, or 48%, from the year-ago six-month period, primarily reflecting the investment of a portion of the proceeds from the automobile loan sales.

 

Average total core deposits in the first six months of 2004 were $15.9 billion, up $0.7 billion, or 4%, from the year-ago period. This growth primarily reflected a $1.0 billion, or 17%, increase in interest bearing demand deposits, partially offset by a $0.5 billion, or 17%, decline in retail CDs.

 

28


Table of Contents

Table 6 reflects average balance sheets and rates earned and paid on interest-earning assets and interest-bearing liabilities, respectively for the first six-month periods of 2004 and 2003:

 

Table 6 - Condensed Consolidated YTD Average Balance Sheets and Net Interest Margin Analysis

 

(in millions)


   YTD Average Balances

    YTD Average Rates (3)

 
               2004 vs. 2003

   

Fully Tax Equivalent Basis


   2004

   2003

   Amount

    %

        2004    

        2003    

 

Assets

                                        

Interest bearing deposits in banks

   $ 74    $ 41    $ 33     80.5     0.88 %   1.58 %

Trading account securities

     22      17      5     29.4     3.36     4.40  

Federal funds sold and securities purchased under resale agreements

     130      63      67     N.M.     1.28     2.15  

Mortgages held for sale

     231      531      (300 )   (56.5 )   5.25     5.47  

Securities:

                                        

Taxable

     4,753      3,202      1,551     48.4     3.94     4.85  

Tax exempt

     423      290      133     45.9     6.97     6.88  
    

  

  


 

 

 

Total Securities

     5,176      3,492      1,684     48.2     4.19     5.02  
    

  

  


 

 

 

Loans and Leases:

                                        

Commercial and industrial

     5,451      5,625      (174 )   (3.1 )   4.37     5.28  

Real Estate

                                        

Construction

     1,322      1,214      108     8.9     3.69     4.06  

Commercial

     2,891      2,593      298     11.5     4.63     5.35  

Consumer

                                        

Automobile loans

     2,689      2,954      (265 )   (9.0 )   7.05     7.73  

Automobile leases

     2,064      1,153      911     79.0     5.02     5.29  
    

  

  


 

 

 

Automobile loans and leases

     4,753      4,107      646     15.7     6.17     7.05  
    

  

  


 

 

 

Home equity

     4,011      3,298      713     21.6     4.88     5.08  

Residential mortgage

     2,830      1,859      971     52.2     5.37     5.80  

Other loans

     377      383      (6 )   (1.6 )   7.37     6.85  
    

  

  


 

 

 

Total Consumer

     11,971      9,647      2,324     24.1     5.51     6.13  
    

  

  


 

 

 

Total Loans and Leases

     21,635      19,079      2,556     13.4     5.00     5.64  
    

  

  


 

 

 

Allowance for loan and lease losses

     328      343      (15 )   (4.4 )            
    

  

                          

Net loans and leases

     21,307      18,736      2,571     13.7              
    

  

                

 

Total earning assets

     27,268      23,223      4,045     17.4     4.83 %   5.52 %
    

  

  


 

 

 

Operating lease assets

     1,070      1,937      (867 )   (44.8 )            

Cash and due from banks

     756      738      18     2.4              

Intangible assets

     217      218      (1 )   (0.5 )            

All other assets

     2,075      1,974      101     5.1              
    

  

  


 

           

Total Assets

   $ 31,058    $ 27,747    $ 3,311     11.9              
    

  

  


 

           

Liabilities and Shareholders’ Equity

                                        

Core deposits

                                        

Non-interest bearing deposits

   $ 3,120    $ 2,984    $ 136     4.6              

Interest bearing demand deposits

     6,889      5,868      1,021     17.4     0.92 %   1.44 %

Savings deposits

     2,829      2,788      41     1.5     0.88     1.63  

Retail certificates of deposit

     2,400      2,880      (480 )   (16.7 )   3.37     3.81  

Other domestic time deposits

     618      678      (60 )   (8.8 )   3.34     3.92  
    

  

  


 

 

 

Total core deposits

     15,856      15,198      658     4.3     1.49     2.18  
    

  

  


 

 

 

Domestic time deposits of $100,000 or more

     792      789      3     0.4     2.26     2.66  

Brokered time deposits and negotiable CDs

     1,822      1,198      624     52.1     1.54     1.88  

Foreign time deposits

     545      470      75     16.0     0.74     1.05  
    

  

  


 

 

 

Total deposits

     19,015      17,655      1,360     7.7     1.51     2.15  
    

  

  


 

 

 

Short-term borrowings

     1,499      1,790      (291 )   (16.3 )   0.82     1.11  

Federal Home Loan Bank advances

     1,272      1,242      30     2.4     2.51     1.80  

Subordinated notes and other long-term debt, including preferred capital securities

     5,590      3,791      1,799     47.5     2.28     2.97  
    

  

  


 

 

 

Total interest bearing liabilities

     24,256      21,494      2,762     12.9     1.68 %   2.19 %
    

  

  


 

 

 

All other liabilities

     1,381      1,111      270     24.3              

Shareholders’ equity

     2,301      2,158      143     6.6              
    

  

  


 

           

Total Liabilities and Shareholders’ Equity

   $ 31,058    $ 27,747    $ 3,311     11.9              
    

  

  


 

           

Net interest rate spread

                               3.15 %   3.33 %

Impact of non-interest bearing funds on margin

                               0.17     0.19  
                                

 

Net Interest Margin

                               3.32 %   3.52 %
                                

 

 

29


Table of Contents

Provision for Credit Losses

 

The provision for credit losses is the expense necessary to maintain the ALLL and the allowance for unfunded loan commitments (AULC) at levels adequate to absorb Management’s estimate of inherent losses in the total loan and lease portfolio, unfunded loan commitments, and letters of credit. Taken into consideration are such factors as current period net charge-offs that are charged against these allowances, current period loan and lease growth and any related estimate of likely losses associated with that growth based on historical experience, the current economic outlook, and the anticipated impact on credit quality of existing loans and leases and unfunded commitments and letters of credit (see Allowances for Credit Losses for additional discussion and Table 14).

 

The provision for credit losses in the 2004 second quarter was $5.0 million, a $44.2 million reduction from the year-ago quarter and a $20.6 million decline from the 2004 first quarter. This reduction in provision expense reflected the $9.7 million commercial loan recovery and overall improved portfolio quality performance, as well as an improved economic outlook, only partially offset by provision expense related to loan growth. As previously disclosed, effective January 1, 2004, the company adopted a more quantitative approach to calculating the economic reserve component of the ALLL, making this component more responsive to changes in economic conditions. This change, combined with the existing quantitative approach for determining the transaction reserve component, as well as changes to the specific reserve component, will result in more volatility in the total ALLL and corresponding provision for credit losses (see Credit Risk for additional discussion).

 

The provision for credit losses in the first six months of 2004 was $30.6 million, a $55.4 million, or 64%, decline from the comparable year-ago period. This reduction reflected the same factors impacting second quarter year-over-year performance.

 

30


Table of Contents

Non-Interest Income

 

Table 7 reflects non-interest income detail for each of the past five quarters, and the first six-months of 2004 and 2003:

 

Table 7 - Non-Interest Income

 

     2004

    2003

   2Q04 vs. 2Q03

 

(in thousands)


   Second

    First

    Fourth

   Third

    Second

   Amount

    %

 

Service charges on deposit accounts

   $ 43,596     $ 41,837     $ 44,763    $ 42,294     $ 40,914    $ 2,682     6.6 %

Trust services

     16,708       16,323       15,793      15,365       15,580      1,128     7.2  

Brokerage and insurance

     13,523       15,197       14,344      13,807       14,196      (673 )   (4.7 )

Mortgage banking

     23,322       (4,296 )     9,677      30,193       7,185      16,137     N.M.  

Bank owned life insurance

     11,309       10,485       10,410      10,438       11,043      266     2.4  

Gain on sale of automobile loans

     4,890       9,004       16,288      —         13,496      (8,606 )   (63.8 )

Gain on sale of branch offices

     —         —         —        13,112       —        —       —    

Other service charges and fees

     10,645       9,513       9,237      10,499       11,372      (727 )   (6.4 )

Securities gains (losses)

     (9,230 )     15,090       1,280      (4,107 )     6,887      (16,117 )   N.M.  

Other

     24,659       25,619       19,411      23,543       27,704      (3,045 )   (11.0 )
    


 


 

  


 

  


 

Sub-total before operating lease income

     139,422       138,772       141,203      155,144       148,377      (8,955 )   (6.0 )

Operating lease income

     78,706       88,867       105,307      117,624       128,574      (49,868 )   (38.8 )
    


 


 

  


 

  


 

Total Non-Interest Income

   $ 218,128     $ 227,639     $ 246,510    $ 272,768     $ 276,951    $ (58,823 )   (21.2 )%
    


 


 

  


 

  


 

 

       Six Months Ending June 30,

     YTD 2004 vs. 2003

 

(in thousands)


     2004

     2003

     Amount

     %

 

Service charges on deposit accounts

     $ 85,433      $ 80,783      $ 4,650      5.8 %

Trust services

       33,031        30,491        2,540      8.3  

Brokerage and insurance

       28,720        29,693        (973 )    (3.3 )

Mortgage banking

       19,026        18,310        716      3.9  

Bank owned life insurance

       21,794        22,180        (386 )    (1.7 )

Gain on sale of automobile loans

       13,894        23,751        (9,857 )    (41.5 )

Other service charges and fees

       20,158        21,710        (1,552 )    (7.1 )

Securities gains (losses)

       5,860        8,085        (2,225 )    (27.5 )

Other

       50,278        48,105        2,173      4.5  
      

    

    


  

Sub-total before operating lease income

       278,194        283,108        (4,914 )    (1.7 )

Operating lease income

       167,573        266,767        (99,194 )    (37.2 )
      

    

    


  

Total Non-Interest Income

     $ 445,767      $ 549,875      $ (104,108 )    (18.9 )%
      

    

    


  

 

N.M. - Not Meaningful.

 

2004 Second Quarter versus 2003 Second Quarter

 

Non-interest income decreased $58.8 million, or 21%, from the year-ago quarter. Comparisons with prior-period results are heavily influenced by the decline in operating leases and related operating lease income. These trends are expected to continue as all automobile leases originated since April 2002 are direct financing leases with income reflected in net interest income, not non-interest income. Reflecting the run-off of the operating lease portfolio, operating lease income declined $49.9 million, or 39%, from the 2003 second quarter. Excluding operating lease income, non-interest income decreased $9.0 million, or 6%, from the year-ago quarter with the primary drivers being:

 

  $16.1 million decline in investment securities gains with current quarter securities losses of $9.2 million, including $10.2 million of losses related to investment securities used to offset MSR temporary valuation changes.

 

  $8.6 million, or 64%, decrease in gains on the sale of automobile loans, as the current quarter included $4.9 million of pre-tax gains, compared with $13.5 million of such pre-tax gains in the year-ago quarter. The higher relative gain in the year-ago quarter reflected the higher average rate of the loans sold in that quarter.

 

  $3.0 million, or 11%, decline in other income due to lower fees collected at the end of leases, partially offset by higher letter of credit fees.

 

31


Table of Contents

Partially offset by:

 

  $16.1 million increase in mortgage banking income. This reflected a $16.8 million change in MSR temporary impairment valuations, as the current quarter included a $10.4 million recovery of previously recorded MSR temporary impairment compared with $6.4 million of MSR temporary impairment recognized in the year-ago quarter. The valuation changes included $4.5 million of MSR hedge losses in the current quarter.

 

  $2.7 million, or 7%, increase in service charges on deposit accounts.

 

  $1.1 million, or 7%, increase in trust services income.

 

2004 Second Quarter versus 2004 First Quarter

 

Compared with the 2004 first quarter, non-interest income declined $9.5 million, or 4%. This comparison is also heavily influenced by the decline in operating lease income for the reasons noted above. Reflecting the run-off of the operating lease portfolio, operating lease income declined $10.2 million, or 11%, from the 2004 first quarter. Excluding operating lease income, non-interest income increased $0.7 million from the 2004 first quarter with the primary drivers being:

 

  $27.6 million increase in mortgage banking income. This reflected a $20.5 million change in MSR temporary impairment valuations, as the current quarter included a $10.4 million recovery of previously recorded MSR temporary impairment compared with $10.1 million of MSR temporary impairment recognized in the first quarter. This reversal in MSR temporary impairment valuation between quarters reflected an upward movement in mortgage interest rates in the second quarter. The MSR temporary impairment valuation reserve at June 30, 2004, was $1.4 million. Reflecting the rise of interest rates during the quarter, the value of MSRs as a percent of mortgages serviced for others was 1.21%, up from 0.93% at March 31, 2004. Excluding the MSR temporary impairment valuation change between quarters, mortgage banking income increased $7.1 million, primarily reflecting higher mortgage originations and sales and including $4.5 million of MSR hedge losses in the current quarter.

 

  $1.8 million, or 4%, increase in service charges on deposit accounts.

 

  $1.1 million, or 12%, increase in other service charges and fees.

 

Partially offset by:

 

  $24.3 million decline in securities gains (losses), with the current quarter reflecting $9.2 million in securities losses, compared with $15.1 million of securities gains in the 2004 first quarter. Investment securities are used as an on balance sheet hedge to MSR temporary valuation changes.

 

  $4.1 million decrease in gains on the sale of automobile loans as the current quarter reflected $4.9 million of such gains, compared with $9.0 million of gains in the first quarter.

 

  $1.7 million, or 11%, decline in brokerage and insurance income primarily due to lower annuity sales.

 

2004 First Six Months versus 2003 First Six Months

 

Non-interest income for the first six months of 2004 declined $104.1 million, or 19%, from the comparable year-ago period. Comparisons with prior-period results are heavily influenced by the decline in operating leases and related operating lease income (see above discussion). Reflecting the run-off of the operating lease portfolio, operating lease income for the first six months of 2004 declined $99.2 million, or 37%, from the comparable year-ago period. Excluding operating lease income, non-interest income for the first six months of 2004 decreased $4.9 million, or 2%, from the year-ago period with the primary drivers being:

 

  $9.9 million, or 42%, decrease in gains on the sale of automobile loans, as the current six-month period included $13.9 million of pre-tax gains, compared with $23.8 million of such pre-tax gains in the year-ago period.

 

  $2.2 million decline in investment securities gains with current six-month period securities gains of $5.9 million, compared with $8.1 million of gains in the year-ago six-month period.

 

Partially offset by:

 

  $4.7 million, or 6%, increase in service charges on deposit accounts, primarily reflecting higher NSF and overdraft fees.

 

  $2.5 million, or 8%, increase in trust services income.

 

  $2.2 million, or 4%, increase in other income.

 

32


Table of Contents

Non-Interest Expense

 

Table 8 reflects non-interest expense detail for each of the last five quarters and the first six-month period for 2004 and 2003:

 

Table 8 - Non-Interest Expense

 

     2004

   2003

    2Q04 vs. 2Q03

 

(in thousands)


   Second

   First

   Fourth

    Third

   Second

    Amount

    %

 

Personnel costs

   $ 119,715    $ 121,624    $ 115,762     $ 113,170    $ 105,242     $ 14,473     13.8 %

Outside data processing and other services

     17,563      18,462      15,957       17,478      16,104       1,459     9.1  

Equipment

     16,228      16,086      16,840       16,328      16,341       (113 )   (0.7 )

Net occupancy

     16,258      16,763      14,925       15,570      15,377       881     5.7  

Professional services

     7,836      7,299      12,175       11,116      9,872       (2,036 )   (20.6 )

Marketing

     8,069      7,839      6,895       5,515      8,454       (385 )   (4.6 )

Telecommunications

     4,638      5,194      5,272       5,612      5,394       (756 )   (14.0 )

Printing and supplies

     3,098      3,016      3,417       3,658      2,253       845     37.5  

Amortization of intangible assets

     204      204      204       204      204       —       —    

Loss on early extinguishment of debt

     —        —        15,250       —        —         —       —    

Restructuring reserve releases

     —        —        (351 )     —        (5,315 )     5,315     N.M.  

Other

     25,981      18,457      25,510       18,397      20,168       5,813     28.8  
    

  

  


 

  


 


 

Sub-total before operating lease expense

     219,590      214,944      231,856       207,048      194,094       25,496     13.1  

Operating lease expense

     62,563      70,710      85,609       93,134      102,939       (40,376 )   (39.2 )
    

  

  


 

  


 


 

Total Non-Interest Expense

   $ 282,153    $ 285,654    $ 317,465     $ 300,182    $ 297,033     $ (14,880 )   (5.0 )%
    

  

  


 

  


 


 

 

     Six Months Ending June 30,

     YTD 2004 vs. 2003

 

(in thousands)


   2004

   2003

     Amount

    %

 

Personnel costs

   $ 241,339    $ 218,331      $ 23,008     10.5 %

Outside data processing and other services

     36,025      32,683        3,342     10.2  

Equipment

     32,314      32,753        (439 )   (1.3 )

Net occupancy

     33,021      31,986        1,035     3.2  

Professional services

     15,135      19,157        (4,022 )   (21.0 )

Marketing

     15,908      15,080        828     5.5  

Telecommunications

     9,832      11,095        (1,263 )   (11.4 )

Printing and supplies

     6,114      5,934        180     3.0  

Amortization of intangible assets

     408      408        —       —    

Restructuring reserve releases

     —        (6,315 )      6,315     N.M.  

Other

     44,438      36,873        7,565     20.5  
    

  


  


 

Sub-total before operating lease expense

     434,534      397,985        36,549     9.2  

Operating lease expense

     133,273      214,527        (81,254 )   (37.9 )
    

  


  


 

Total Non-Interest Expense

   $ 567,807    $ 612,512      $ (44,705 )   (7.3 )%
    

  


  


 


N.M. - Not Meaningful.

 

2004 Second Quarter versus 2003 Second Quarter

 

Non-interest expense decreased $14.9 million, or 5%, from the year-ago quarter. Comparisons with prior-period results are influenced by the decline in operating lease expense as the operating lease portfolio continues to run-off (see above operating lease income discussion). Operating lease expense declined $40.4 million, or 39%, from the 2003 second quarter. Excluding operating lease expense, non-interest expense increased $25.5 million, or 13%, from the year-ago quarter with the primary drivers being:

 

  $14.5 million, or 14%, increase in personnel costs, primarily reflecting a $4.3 million increase in pension costs and a $4.2 million increase in health care expense.

 

  $5.8 million, or 29%, increase in other expense, primarily attributable to costs recorded in the current quarter related to investments in partnerships generating tax benefits, of which $3.2 million related to previous periods.

 

  $5.3 million in restructuring reserve releases that lowered expenses in the year-ago quarter.

 

33


Table of Contents
  $1.5 million, or 9%, increase in outside data processing and other services.

 

Partially offset by:

 

  $2.0 million, or 21%, decline in professional services expense.

 

2004 Second Quarter versus 2004 First Quarter

 

Compared with the 2004 first quarter, non-interest expense declined $3.5 million, or 1%. Comparisons with prior-period results are also heavily influenced by the decline in operating lease expense. Operating lease expense declined $8.1 million, or 12%, from the 2004 first quarter. Excluding operating lease expense, non-interest expense increased $4.6 million, or 2%, from the first quarter with the primary drivers being:

 

  $7.5 million increase in other expense primarily related to $5.8 million of costs consisting of investments in partnerships generating tax benefits.

 

Partially offset by:

 

  $1.9 million, or 2%, decrease in personnel costs, primarily reflecting lower employment taxes.

 

  $0.9 million, or 5%, decline in outside data processing and other services.

 

2004 First Six Months versus 2003 First Six Months

 

Non-interest expense for the first six months of 2004 declined $44.7 million, or 7%, from the comparable year-ago period. Comparisons with prior-period results are influenced by the decline in operating lease expense as the operating lease portfolio continues to run-off (see above operating lease income discussion). Operating lease expense declined $81.3 million, or 38%, from the 2003 six-month period. Excluding operating lease expense, non-interest expense for the first six months of 2004 increased $36.5 million, or 9%, from the year-ago period with the primary drivers being:

 

  $23.0 million, or 11%, increase in personnel costs, primarily reflecting a $14.7 million, or 37%, increase in benefits expense and an $8.8 million, or 6%, increase in salaries.

 

  $7.6 million, or 21%, increase in other expense, primarily attributable to $5.8 million of costs related to investments in partnerships generating tax benefits in the current six-month period.

 

  $6.3 million in restructuring reserve releases that lowered expenses in the year-ago six-month period.

 

  $3.3 million, or 10%, increase in outside data processing and other services.

 

Partially offset by:

 

  $4.0 million, or 21%, decline in professional services expense.

 

34


Table of Contents

Operating Lease Assets

 

Table 9 reflects operating lease assets performance detail for each of the last five quarters, and the first six-month period for 2004 and 2003:

 

Table 9 - Operating Lease Assets Performance

 

     2004

    2003

    2Q04 vs. 2Q03

 
     Second

    First

    Fourth

    Third

    Second

    Amount

    %

 

Balance Sheet (in millions)

                                                      

Average operating lease assets outstanding

   $ 977     $ 1,166     $ 1,355     $ 1,565     $ 1,802     $ (825 )   (45.8 )%

Income Statement (in thousands)

 

                                             

Net rental income

     72,402     $ 83,517     $ 98,223     $ 109,645     $ 120,502     $ (48,100 )   (39.9 )%

Fees

     4,838       3,543       5,204       5,372       5,414       (576 )   (10.6 )

Recoveries - early terminations

     1,466       1,807       1,880       2,607       2,658       (1,192 )   (44.8 )
    


 


 


 


 


 


 

Total Operating Lease Income

     78,706       88,867       105,307       117,624       128,574       (49,868 )   (38.8 )
    


 


 


 


 


 


 

Depreciation and residual losses at termination

     57,412       63,932       76,768       83,112       91,387       (33,975 )   (37.2 )

Losses - early termination

     5,151       6,778       8,841       10,022       11,552       (6,401 )   (55.4 )
    


 


 


 


 


 


 

Total Operating Lease Expense

     62,563       70,710       85,609       93,134       102,939       (40,376 )   (39.2 )
    


 


 


 


 


 


 

Net Earnings Contribution

   $ 16,143     $ 18,157     $ 19,698     $ 24,490     $ 25,635     $ (9,492 )   (37.0 )%
    


 


 


 


 


 


 

Earnings ratios (1)

                                                      

Net rental income

     29.6 %     28.7 %     29.0 %     28.0 %     26.7 %     2.9 %   10.9 %

Depreciation and residual losses at termination

     23.5 %     21.9 %     22.7 %     21.2 %     20.3 %     3.2 %   15.8 %

(1) As a percent of average operating lease assets, quartlery amounts annualized.

 

     Six Months Ended June 30,

    YTD 2004 vs. 2003

 
     2004

    2003

    Amount

    %

 

Balance Sheet (in millions)

                              

Average operating lease assets outstanding

   $ 1,070     $ 1,937     $ (867 )   (44.8 )%

Income Statement (in thousands)

                              

Net rental income

     155,919     $ 250,776     $ (94,857 )   (37.8 )

Fees

     8,381       11,047       (2,666 )   (24.1 )

Recoveries - early terminations

     3,273       4,944       (1,671 )   (33.8 )
    


 


 


 

Total Operating Lease Income

     167,573       266,767       (99,194 )   (37.2 )
    


 


 


 

Depreciation and residual losses at termination

     121,344       190,670       (69,326 )   (36.4 )

Losses - early termination

     11,929       23,857       (11,928 )   (50.0 )
    


 


 


 

Total Operating Lease Expense

     133,273       214,527       (81,254 )   (37.9 )
    


 


 


 

Net Earnings Contribution

   $ 34,300     $ 52,240     $ (17,940 )   (34.3 )%
    


 


 


 

Earnings ratios (1)

                              

Net rental income

     29.1 %     25.9 %     3.3 %   12.6 %

Depreciation and residual losses at termination

     22.7 %     19.7 %     3.0 %   15.2 %

(1) As a percent of average operating lease assets, quartlery amounts annualized.

 

35


Table of Contents

Operating lease assets represent automobile leases originated before May 2002. This operating lease portfolio will run-off over time since all automobile lease originations after April 2002 have been recorded as direct financing leases and are reported in the automobile loan and lease category in earning assets. As a result, the non-interest income and non-interest expenses associated with the operating lease portfolio will also decline over time.

 

2004 Second Quarter versus 2003 Second Quarter and 2004 First Quarter

 

Average operating lease assets in the 2004 second quarter were $1.0 billion, down 46% from the year-ago quarter and 12% from the 2004 first quarter.

 

Operating lease income, which totaled $78.7 million in the 2004 second quarter, represented 36% of non-interest income in the quarter. Operating lease income was down $49.9 million, or 39%, from the year-ago quarter and $10.2 million, or 11%, from the 2004 first quarter, reflecting the declines in average operating leases. As no new operating leases have been originated after April 2002, the operating lease asset balances will continue to decline through both depreciation and lease terminations. Net earnings contribution was down 37% and 11%, respectively, from the year-ago and 2004 first quarter. Fees declined 11% from the year-ago quarter, but increased $1.3 million, or 37%, from the first quarter, reflecting the recognition of deferred fees resulting from higher than expected prepayments of operating lease assets. Recoveries from early terminations declined 45% from the year-ago quarter and 19% from the first quarter.

 

Operating lease expense totaled $62.6 million, down $40.4 million, or 39%, from the year-ago quarter and down $8.1 million, or 12%, from the 2004 first quarter. These declines also reflected the fact that this portfolio is decreasing over time as no new operating leases are being originated. Losses on early terminations, included in operating lease expense, declined $6.4 million, or 55%, from the year-ago quarter, and $1.6 million, or 24%, from the prior quarter.

 

Losses on operating lease assets consist of residual losses at termination and losses on early terminations. Residual losses arise if the ultimate value or sales proceeds from the automobile are less then Black Book value, which represents the insured amount under the company’s residual value insurance policies. This situation may occur due to excess wear-and-tear or excess mileage not collected from the lessee. Losses on early terminations occur when a lessee, due to credit or other reasons, turns in the automobile before the end of the lease term. A loss is realized if the automobile is sold for a value less than the net book value at the date of turn-in. Such losses are not covered by the residual value insurance policies. To the extent the company is successful in collecting any deficiency from the lessee, amounts received are recorded as recoveries from early terminations.

 

The ratio of operating lease asset credit losses, net of recoveries, to average operating lease assets outstanding was an annualized 1.51% in the current quarter, 1.97% in the year-ago quarter, and 1.78% in the 2004 first quarter.

 

On a quarterly basis, Management evaluates the amount of residual value losses that it anticipates will result from the estimated fair value of a leased vehicle being less than the residual value inherent in the lease. Fair value includes estimated net proceeds from the sale of the leased vehicle plus expected residual value insurance proceeds and amounts expected to be collected from the lessee for excess mileage and other items that are billable under terms of the lease contract. When estimating the amount of expected insurance proceeds, Management takes into consideration policy caps that exist in two of the residual value insurance policies and whether it expects aggregate claims under such policies to exceed these caps. Management currently anticipates that aggregate claims for losses under the policy that insures residual values on automobile leases originated prior to October 2000 will exceed the policy cap of $120 million. Residual value losses exceeding the insurance policy cap are reflected in higher depreciation expense over the remaining life of the affected automobile lease. Also as part of its quarterly analysis, Management evaluates automobile leases individually for impairment.

 

All automobile leases covered under the two policies containing caps are accounted for using the operating lease method of accounting. Accordingly, residual value losses are provided for as additional depreciation expense over the remaining term to maturity of the underlying lease so that the carrying amount of the operating lease asset at the end of the lease term does not exceed its estimated fair value. At June 30, 2004, estimated future residual value losses on operating leases outstanding were expected to be between $15 million to $19 million. As of June 30, 2004, $11.7 million of this amount had been provided for through additional depreciation expense. Any remaining losses above $11.7 million will be provided for through additional depreciation expense over future periods.

 

36


Table of Contents

2004 First Six Months versus 2003 First Six Months

 

Average operating lease assets in the first six months of 2004 were $1.1 billion, down 45% from the comparable year-ago period.

 

Operating lease income, which totaled $167.6 million in the first six months of 2004, was down $99.2 million, or 37%, from the comparable year-ago period, reflecting the decline in average operating leases. As no new operating leases have been originated after April 2002, the operating lease asset balances will continue to decline through both depreciation and lease terminations. Net rental income for the first six months of 2004 was down 38%, with fees declining 24%. Recoveries from early terminations declined 34% from the comparable year-ago six-month period.

 

Operating lease expense for the first six months of 2004 totaled $133.3 million, down $81.3 million, or 38%, from the year-ago period. This decline also reflected the fact that this portfolio is decreasing over time as no new operating leases are being originated. Losses on early terminations for the first six months of 2004, included in operating lease expense, declined $11.9 million, or 50%, from the comparable year-ago period.

 

The ratio of operating lease asset credit losses, net of recoveries, to average operating lease assets outstanding for the first six months was an annualized 1.62% in the current six-month period, down from 1.95% in the comparable year-ago period.

 

Provision for Income Taxes

 

The provision for income taxes in the second quarter of 2004 was $43.4 million and represented an effective tax rate on income before taxes of 28.3%. The provision for income taxes increased $6.7 million from the year-ago quarter, primarily due to higher pre-tax income. The effective tax rates in the second quarter of 2003 and first quarter of 2004 were 27.5% and 25.1%, respectively. For the first six months of 2004, provision for income taxes was $78.3 million and represented an effective tax rate on income before taxes of 26.8%. This increased $11.0 million from the same period in 2003, in which the effective tax rate was 26.3%, reflecting higher pre-tax income.

 

Each quarter, taxes for the full year are estimated and year-to-date tax accrual adjustments are made. Revisions to the full year estimate of accrued taxes occur periodically due to changes in the tax rates, audit resolution with taxing authorities, and newly enacted statutory, judicial, and regulatory guidance. These changes, when they occur, affect accrued taxes and can result in fluctuations in the quarterly effective tax rate.

 

The cost of investments in partnerships, along with the related tax credit is recognized in the financial statements as a component of income taxes under the effective yield method. The cost of the investment in partnerships is reported in non-interest expense. During the second quarter 2004, $5.8 million of costs related to such investments in partnerships were recorded in non-interest expense.

 

In accordance with FAS 109, Accounting for Income Taxes, no deferred income taxes are to be recorded when a company intends to permanently reinvest their earnings from a foreign activity. As of June 30, 2004, the company intended to permanently reinvest the earnings from its foreign asset securitization activities of approximately $79.4 million.

 

Management expects the 2004 effective tax rate to remain below 30% as the level of tax-exempt income, general business credits, and asset securitization activities remain consistent with prior years.

 

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. The company is subject to credit risk in lending, trading, and investment activities. The nature and degree of credit risk is a function of the types of transactions, the structure of those transactions, and the parties involved. The majority of the company’s credit risk is associated with lending activities, as the acceptance and management of credit risk is central to profitable lending. Credit risk represents a limited portion of the total risks associated with the investment portfolio and is incidental to trading activities. Credit risk is mitigated through a combination of credit policies and processes and portfolio diversification. These include origination/underwriting criteria, portfolio monitoring processes, and effective problem asset management. There are very specific and differing methodologies for managing credit risk for commercial credits compared with consumer credits (see Credit Risk Management section of the company’s 2003 Form 10-K for a complete discussion).

 

37


Table of Contents

Loan and Lease Composition

 

Table 10 reflects period-end loan and lease portfolio mix by type of loan or lease, as well as by business segment:

 

Table 10 - Loans and Lease Portfolio Composition

 

   

June 30,

2004 (1)


   

March 31,

2004


   

December 31,

2003


   

September 30,

2003


   

June 30,

2003


 

(in millions)


  Amount

  %

    Amount

  %

    Amount

  %

    Amount

  %

    Amount

  %

 

By Type

                                                           

Commercial and industrial

  $ 5,277   23.3 %   $ 5,480   25.9 %   $ 5,314   25.2 %   $ 5,433   25.7 %   $ 5,532   28.9 %

Commercial real estate

    4,514   19.9       4,272   20.2       4,172   19.8       4,047   19.1       3,951   20.7  
   

 

 

 

 

 

 

 

 

 

Total Commercial

    9,791   43.2       9,752   46.0       9,486   45.0       9,480   44.8       9,483   49.6  
   

 

 

 

 

 

 

 

 

 

Consumer

                                                           

Automobile loans

    1,815   8.0       2,267   10.7       2,992   14.2       3,709   17.5       2,367   12.4  

Automobile leases

    2,185   9.6       2,066   9.7       1,902   9.0       1,688   8.0       1,481   7.9  

Home equity

    4,315   19.0       3,980   18.8       3,792   18.0       3,590   17.0       3,436   18.0  

Residential mortgage

    3,284   14.5       2,757   13.0       2,531   12.0       2,326   11.0       1,915   10.0  

Other loans

    386   1.7       372   1.8       372   1.8       380   1.7       378   2.1  
   

 

 

 

 

 

 

 

 

 

Total Consumer

    11,984   52.9       11,442   54.0       11,589   55.0       11,693   55.2       9,577   50.4  
   

 

 

 

 

 

 

 

 

 

Total Loans and Leases

  $ 21,776   96.1 %   $ 21,194   100.0 %   $ 21,075   100.0 %   $ 21,173   100.0 %   $ 19,060   100.0 %
   

 

 

 

 

 

 

 

 

 

Total automobile loans and leases

  $ 3,999   17.6     $ 4,333         $ 4,894         $ 5,397         $ 3,848      

Operating lease assets

    889   3.9       1,071           1,260           1,455           1,673      

Securitized loans

    —     —         28           37           49           1,076      
   

 

 

 

 

 

 

 

 

 

Total Automobile Exposure (2)

  $ 4,888   21.6 %   $ 5,432   24.4 %   $ 6,191   27.7 %   $ 6,901   30.4 %   $ 6,597   30.2 %
   

 

 

 

 

 

 

 

 

 

Total Credit Exposure

  $ 22,664   100.0 %   $ 22,293   100.0 %   $ 22,372   100.0 %   $ 22,677   100.0 %   $ 21,809   100.0 %
   

 

 

 

 

 

 

 

 

 

By Business Segment (3)

                                                           

Regional Banking

                                                           

Central Ohio

  $ 5,652   24.9 %   $ 4,988   22.4 %   $ 4,652   20.8 %   $ 4,491   19.8 %   $ 4,080   18.7 %

Northern Ohio

    2,694   11.9       2,681   12.0       2,579   11.5       2,639   11.6       2,712   12.4  

Southern Ohio/Kentucky

    1,759   7.8       1,703   7.6       1,677   7.5       1,623   7.2       1,547   7.1  

West Michigan

    2,216   9.8       2,155   9.7       2,077   9.3       2,028   8.9       1,967   9.0  

East Michigan

    1,359   6.0       1,341   6.0       1,268   5.7       1,306   5.8       1,225   5.6  

West Virginia

    811   3.6       808   3.6       802   3.6       802   3.5       796   3.6  

Indiana

    811   3.6       753   3.4       731   3.3       741   3.3       729   3.3  
   

 

 

 

 

 

 

 

 

 

Total Regional Banking

    15,302   67.5       14,429   64.7       13,786   61.7       13,630   60.1       13,056   59.9  
   

 

 

 

 

 

 

 

 

 

Dealer Sales

    5,840   25.8       6,399   28.7       7,095   31.6       7,598   33.5       7,373   33.8  

Private Financial Group

    1,381   6.1       1,322   5.9       1,296   5.8       1,260   5.6       1,181   5.4  

Treasury / Other

    141   0.6       143   0.7       195   0.9       189   0.8       199   0.9  
   

 

 

 

 

 

 

 

 

 

Total Credit Exposure

  $ 22,664   100.0 %   $ 22,293   100.0 %   $ 22,372   100.0 %   $ 22,677   100.0 %   $ 21,809   100.0 %
   

 

 

 

 

 

 

 

 

 


(1) Effective June 30, 2004, $282 million of commercial and industrial loans were reclassified to commercial real estate to conform to the classification of these loans with the presentation of similar loans.
(2) Total Loans and leases, operating lease assets and securitized loans.
(3) Prior period amounts have been reclassified to conform to the current period business segment structure.

 

During 2004, the composition of the loan and lease portfolio changed such that lower credit risk home equity loans and residential mortgages represented 19% and 14%, respectively, of total credit exposure at June 30, 2004, up from 18% and 10%, respectively, a year earlier. Conversely, C&I loans have declined from 29% a year ago to 23% at June 30, 2004, reflecting, in part, strategies to exit large, individual commercial credits, including out-of-footprint shared national credits.

 

At the beginning of the 2004 second quarter, the criteria for categorizing commercial loans as either C&I loans or CRE loans was clarified. The new criteria are based on the purpose of the loan. Previously, the categorization was based on the nature of the collateral securing, or partially securing, the loan. As a result of this change, $282 million in C&I loans were reclassified to CRE loans effective June 30, 2004. This change had no impact on total commercial loans, underlying credit quality, or 2004 second quarter reported income. Under this new methodology, as new loans are originated or existing loans renewed, loans secured by owner-occupied real estate will be categorized as C&I loans (previously CRE loans) and unsecured loans for the purpose of developing real estate will be categorized as CRE loans (previously C&I loans).

 

38


Table of Contents

The company also has a portfolio of automobile operating lease assets. Although these assets are reflected on the balance sheet, they are not part of total loans and leases or earning assets. In addition, prior to June 30, 2004, there was a small pool of securitized automobile loans, which represented off-balance sheet securitized automobile loan assets. Both of these asset classes represent automobile financing credit exposure, despite not being components of total loans and leases. As such, operating lease assets and securitized loans are added to the on-balance sheet automobile loans and leases to determine a total automobile financing exposure, which Management finds helpful in evaluating the overall credit risk for the company.

 

On June 30, 2004, $512 million of automobile loans were sold and $102 million of automobile loans were transferred to loans held for sale. Combined, these transactions resulted in second quarter net pre-tax gains on the sale of automobile loans of $4.9 million: $5.1 million associated with the $512 million sale, partially offset by a $0.2 million lower of cost or market write-down on the loans held for sale. On a combined basis, these transactions increased the total automobile loans sold since the beginning of 2003 to $3.6 billion. These sales represented a continuation of a strategy to reduce exposure to automobile financing to approximately 20% of total credit exposure (see Table 10). At June 30, 2004, this exposure was $4.9 billion, down from $6.2 billion at year-end, and represented 22% of total credit exposure, down from 24% at the end of the last quarter and from 33% at the end of 2002.

 

Net Loan and Lease Charge-offs

 

Table 11 reflects net loan and lease charge-off detail for each of the last five quarters, and the first six-month period for 2003 and 2004:

 

Table 11 - Net Loan and Lease Charge-offs

 

Net Charge-offs by Loan and Lease Type

                                        
     2004

    2003

 

(in thousands)


   Second

    First

    Fourth

    Third

    Second

 

Commercial and industrial

   $ (2,803 )   $ 5,956     $ 31,186     $ 12,222     $ 26,546  

Commercial real estate

     2,940       1,637       5,743       3,621       607  
    


 


 


 


 


Total Commercial

     137       7,593       36,929       15,843       27,153  
    


 


 


 


 


Consumer

                                        

Automobile loans

     5,604       13,422       11,346       10,773       7,524  

Automobile direct financing leases

     2,159       3,159       1,936       1,450       1,422  
    


 


 


 


 


Automobile loans and leases

     7,763       16,581       13,282       12,223       8,946  
    


 


 


 


 


Home equity

     3,019       3,116       3,464       3,416       3,671  

Residential mortgage

     302       316       174       246       267  

Other loans

     1,294       1,021       1,294       1,046       1,019  
    


 


 


 


 


Total Consumer

     12,378       21,034       18,214       16,931       13,903  
    


 


 


 


 


Total Net Charge-offs

   $ 12,515     $ 28,627     $ 55,143     $ 32,774     $ 41,056  
    


 


 


 


 


Net Charge-offs - Annualized Percentages

                                        
     2004

    2003

 
     Second

    First

    Fourth

    Third

    Second

 

Commercial and industrial

     (0.20 )%     0.44 %     2.32 %   $ 0.91 %     1.89 %

Commercial real estate

     0.28       0.16       0.56       0.36       0.06  
    


 


 


 


 


Total Commercial

     0.01       0.32       1.55       0.68       1.14  
    


 


 


 


 


Consumer

                                        

Automobile loans

     0.96       1.77       1.29       1.20       1.06  

Automobile direct financing leases

     0.40       0.64       0.43       0.36       0.44  
    


 


 


 


 


Automobile loans and leases

     0.69       1.32       1.00       0.94       0.87  
    


 


 


 


 


Home equity

     0.29       0.32       0.38       0.39       0.44  

Residential mortgage

     0.04       0.05       0.03       0.05       0.06  

Other loans

     1.30       1.15       1.34       1.14       1.08  
    


 


 


 


 


Total Consumer

     0.41       0.70       0.61       0.61       0.57  
    


 


 


 


 


Net Charge-offs as a % of Average Loans

     0.23 %     0.53 %     1.03 %     0.64 %     0.85 %
    


 


 


 


 


 

39


Table of Contents

Table 11 - Net Loan and Lease Charge-offs, Continued

 

Net Charge-offs by Loan and Lease Type

 

       Six Months Ending June 30,

 

(in thousands)


     2004

     2003

 

Commercial and industrial

     $ 3,153      $ 41,450  

Commercial real estate

       4,577        1,153  
      


  


Total Commercial

       7,730        42,603  
      


  


Consumer

                   

Automobile loans

       19,026        18,147  

Automobile direct financing leases

       5,318        2,342  
      


  


Automobile loans and leases

       24,344        20,489  
      


  


Home equity

       6,135        7,724  

Residential mortgage

       618        412  

Other loans

       2,315        2,664  
      


  


Total Consumer

       33,412        31,289  
      


  


Total Net Charge-offs

     $ 41,142      $ 73,892  
      


  


Net Charge-offs - Annualized Percentages

 

       Six Months Ending June 30,

 
       2004

     2003

 

Commercial and industrial

       0.12 %      1.47 %

Commercial real estate

       0.22        0.06  
      


  


Total Commercial

       0.16        0.90  
      


  


Consumer

                   

Automobile loans

       1.42        1.23  

Automobile direct financing leases

       0.52        0.40  
      


  


Automobile loans and leases

       1.02        1.63  
      


  


Home equity

       0.31        0.47  

Residential mortgage

       0.04        0.04  

Other loans

       1.23        1.39  
      


  


Total Consumer

       0.56        0.65  
      


  


Net Charge-offs as a % of Average Loans

       0.38 %      0.77 %
      


  


 

2004 Second Quarter versus 2003 Second Quarter and 2004 First Quarter

 

Total net charge-offs for the 2004 second quarter were $12.5 million, or an annualized 0.23% of average total loans and leases. This was a reduction from $41.1 million, or 0.85%, in the year-ago quarter and from $28.6 million, or 0.53% of average total loans and leases, in the prior quarter. Total net charge-offs in the current and 2004 first quarter were influenced by one-time events.

 

Current quarter total net charge-offs were reduced by a $9.7 million one-time recovery on a C&I loan charged-off in the fourth quarter of 2002. This recovery lowered total commercial (C&I and CRE) net charge-offs by an annualized 39 basis points and total loan and lease net charge-offs by 18 basis points. Excluding the impact of this recovery, current quarter total net charge-offs would have been $22.2 million, or an annualized 0.41% of average total loans and leases. As previously reported, total net charge-offs in the 2004 first quarter included a one-time $4.7 million cumulative increase in automobile loan and lease charge-offs related to the accounting treatment of certain auto-related insurance policies. Excluding the 8 basis point impact of this adjustment, 2004 first quarter net charge-offs would have represented 0.45% of average total loans and leases.

 

Total commercial (C&I and CRE) net charge-offs in the second quarter were only $0.1 million. Adjusting for the $9.7 million recovery noted above (39 basis point impact), total commercial net charge-offs would have been $9.8 million, or an annualized 0.40% of related loans, down from $27.2 million, or 1.14% of related loans, in the year-ago quarter, and up from $7.6 million, or 0.32%, in the 2004 first quarter.

 

Total consumer net charge-offs in the current quarter were $12.4 million, or an annualized 0.41% of related loans. This compared with $13.9 million, or 0.57%, in the year-ago quarter, and $21.0 million, or 0.70% of related loans, in the 2004 first quarter. First quarter net consumer charge-offs included 15 basis points related to the one-time $4.7 million cumulative adjustment noted above.

 

40


Table of Contents

Total automobile loan and lease net charge-offs in the 2004 second quarter were $7.8 million, or 0.69% of average automobile loans and leases. This compared with $8.9 million of net charge-offs, or 0.87%, in the year-ago quarter and $16.6 million, or 1.32%, in the first quarter. The first quarter net charge-offs included 37 basis points from the one-time $4.7 million cumulative adjustment.

 

2004 First Six Months versus 2003 First Six Months

 

Total net charge-offs for the first six months of 2004 were $41.1 million, or an annualized 0.38% of average total loans and leases. This was a reduction from $73.8 million, or 0.77%, in the comparable year-ago period.

 

Total commercial (C&I and CRE) net charge-offs in the first six months of 2004 were only $7.7 million, or 0.16%, down from $42.6 million, or 0.90%, in the comparable year-ago period. The decline from the year-ago period reflected a $9.7 million C&I recovery in the 2004 first six-month period.

 

Total consumer net charge-offs in the first six months of 2004 were $33.4 million, or 0.56% of related loans. This compared with $31.2 million, or 0.65%, in the comparable year-ago period.

 

Total automobile loan and lease net charge-offs in the first six months of 2004 were $24.3 million, or 1.02% of average automobile loans and leases. This compared with $20.5 million, or 1.00% of average automobile loans and leases, in the year-ago six-month period.

 

For the second half of 2004, total loan and lease net charge-offs are expected to be in the 0.40%-0.45% range, including third and fourth quarter seasonality associated with automobile loan and lease net charge-offs.

 

Non-performing Assets and Past Due Loans and Leases

 

Table 12 reflects period-end NPAs and past due loans and leases detail for each of the last five quarters:

 

Table 12 - Non-Performing Assets and Past Due Loans and Leases

 

     Three Months Ended

 

(in thousands)


   June 30,
2004


   

March 31,

2004


   

December 31,

2003


   

September 30,

2003


   

June 30,

2003


 

Non-accrual loans and leases

                                        

Commercial and industrial

   $ 32,044     $ 45,056     $ 43,387     $ 82,413     $ 86,021  

Commercial real estate

     15,782       20,019       22,399       30,545       22,398  

Residential mortgage

     13,952       12,052       9,695       8,923       11,735  
    


 


 


 


 


Total non-performing loans and leases (NPLs)

     61,778       77,127       75,481       121,881       120,154  

Other real estate, net

     12,918       14,567       11,905       15,196       13,568  
    


 


 


 


 


Total Non-performing Assets (NPAs)

   $ 74,696     $ 91,694     $ 87,386     $ 137,077     $ 133,722  
    


 


 


 


 


Accruing loans and leases past due 90 days or more

   $ 51,490     $ 59,697     $ 55,913     $ 66,060     $ 55,287  
    


 


 


 


 


NPLs as a % of total loans and leases

     0.28 %     0.36 %     0.36 %     0.58 %     0.63 %

NPLs as a % of total loans and leases and other real estate

     0.34 %     0.43 %     0.41 %     0.65 %     0.70 %

Allowance for loan and lease losses as a % of:

                                        

NPLs

     464 %     383 %     397 %     276 %     256 %

NPAs

     384 %     322 %     343 %     245 %     230 %

Allowance for loan and lease losses plus allowance for unfunded commitments and letters of credit:

                                        

NPLs

     515 %     425 %     444 %     304 %     284 %

NPAs

     426 %     357 %     384 %     270 %     255 %

Accruing loans and leases past due 90 days or more to total loans and leases

     0.24 %     0.28 %     0.27 %     0.31 %     0.29 %

 

41


Table of Contents

NPAs were $74.7 million at June 30, 2004, down $59.0 million, or 44%, from the prior year, and down $17.0 million, or 19%, from March 31, 2004. NPAs as a percent of total loans and leases and other real estate were 0.34% at June 30, 2004, down from 0.70% a year-ago and from 0.43% at March 31, 2004. NPAs at June 30, 2004, included $23.3 million of lower-risk residential real estate related assets, which represented 31% of total NPAs. This compared with $20.7 million, or 15%, at the end of the year-ago quarter.

 

The over 90-day delinquent, but still accruing, ratio was 0.24% at June 30, 2004, down from 0.29% a year ago and 0.28% at March 31, 2004.

 

Table 13 - Non-Performing Asset Activity

 

     Three Months Ended

 

(in thousands)


   June 30,
2004


   

March 31,

2004


    December 31,
2003


    September 30,
2003


    June 30,
2003


 

Beginning of Period

   $ 91,694     $ 87,386     $ 137,077     $ 133,722     $ 140,725  

New non-performing assets

     25,727       27,208       38,367       52,213       83,104  

Returns to accruing status

     (1,493 )     (54 )     (454 )     (319 )     (9,866 )

Loans and lease losses

     (12,872 )     (10,463 )     (39,657 )     (22,090 )     (30,204 )

Payments

     (13,571 )     (10,717 )     (22,710 )     (18,905 )     (26,831 )

Sales

     (14,789 )     (1,666 )     (25,237 )     (7,544 )     (23,206 )
    


 


 


 


 


End of Period

   $ 74,696     $ 91,694     $ 87,386     $ 137,077     $ 133,722  
    


 


 


 


 


 

Table 13 reflects NPA activity and shows that during the 2004 second quarter the level of new NPAs continued to decline and totaled $25.7 million, down 69% from the year-ago quarter, and 5% less than in the first quarter. Also, impacting the decline in period-end NPAs was the sale of $14.8 million of NPAs during the 2004 second quarter.

 

42


Table of Contents

Allowances for Credit Losses (ACL)

 

The allowances for credit losses (ACL) include the allowance for loan and lease losses (ALLL) and the allowance for unfunded loan commitments and letters of credit (AULC). Table 14 reflects activity in the ALLL and AULC for the past five quarters:

 

Table 14 - Allowances for Credit Losses

 

     Three Months Ended

 

(in thousands)


   June 30,
2004


    March 31,
2004


    December 31,
2003


    September 30,
2003


    June 30,
2003


 

Allowance for Loan and Lease Losses, Beginning of Period

   $ 295,377     $ 299,732     $ 336,398     $ 307,667     $ 303,636  

Loan and lease losses

     (30,845 )     (37,167 )     (68,023 )     (43,261 )     (49,985 )

Recoveries of loans previously charged off

     18,330       8,540       12,880       10,487       8,929  
    


 


 


 


 


Net loan and lease losses

     (12,515 )     (28,627 )     (55,143 )     (32,774 )     (41,056 )
    


 


 


 


 


Provision for credit losses

     5,027       25,596       26,341       51,615       49,193  

Net change in allowance for unfunded loan commitments and lettes of credit

     896       3,433       (1,785 )     (457 )     101  

Allowance of assets sold and securitized (1)

     (1,850 )     (4,757 )     (6,079 )     10,347       (4,207 )
    


 


 


 


 


Allowance for Loan and Lease Losses, End of Period

   $ 286,935     $ 295,377     $ 299,732     $ 336,398     $ 307,667  
    


 


 


 


 


Allowance for Unfunded Loan Commitments and Letters of Credit, Beginning of Period

   $ 32,089     $ 35,522     $ 33,737     $ 33,280     $ 33,381  

Net change

     (896 )     (3,433 )     1,785       457       (101 )
    


 


 


 


 


Allowance for Unfunded Loan Commitments and Letters of Credit, End of Period

   $ 31,193     $ 32,089     $ 35,522     $ 33,737     $ 33,280  
    


 


 


 


 


Total Allowances for Credit Losses

   $ 318,128     $ 327,466     $ 335,254     $ 370,135     $ 340,947  
    


 


 


 


 


Allowances for Credit Losses as a % of total loans and leases

     1.46 %     1.55 %     1.59 %     1.75 %     1.79 %

The ALL as a % of total loans and leases

     1.32 %     1.39 %     1.42 %     1.59 %     1.61 %

Components:

                                        

Transaction reserve

     0.86 %     0.91 %     0.88 %     0.98 %     1.05 %

Economic reserve

     0.36       0.38       0.40       0.47       0.45  

Specific reserve

     0.10       0.10       0.14       0.14       0.11  

(1) The third quarter 2003 includes the reserve for loan losses associated with automobile loans contained in one of Huntington’s securitizations trusts consolidated as a result of the adoption of FASB Interpretation No. 46 on July 1, 2003.

 

The June 30, 2004, ALLL was $286.9 million, down from $307.7 million a year ago and from $295.4 million at March 31, 2004. These declines primarily reflected improving credit quality and the change in the mix of the loan portfolio to lower-risk residential mortgages and home equity loans. Expressed as a percent of period-end loans and leases, the ALLL at June 30, 2004, was 1.32%, down from 1.61% a year-ago and from 1.39% at March 31, 2004. The ALLL as a percent of NPAs was 384% at June 30, 2004, up from 230% a year ago and from 322% at March 31, 2004.

 

The June 30, 2004, AULC was $31.2 million, down slightly from $33.3 million at the end of the year-ago quarter, and from $32.1 million at March 31, 2004.

 

On a combined basis, the ACL as a percent of total loans and leases was 1.46% at June 30, 2004, compared with 1.79% a year ago and 1.55% at the end of last quarter. Similarly, the ACL as a percent of NPAs was 426% at June 30, 2004, compared with 255% a year earlier and 357% at March 31, 2004.

 

43


Table of Contents

The ALLL consists of three components, the transaction reserve, the economic reserve, and specific reserves (see the Credit Risk discussion in company’s 2003 Form 10-K for additional discussion).

 

Transaction reserve – This ALLL component is based on historical portfolio performance information. Specifically, the probability-of-default and the loss-in-event-of-default are assigned an expected risk factor based on the type and structure of each credit. Reserve factors are then calculated and applied at an individual loan level for all products.

 

Specific reserve – This ALLL component represents the sum of credit-by-credit reserve decisions for individual C&I and CRE loans when it is determined that the related expected risk factor is insufficient to cover the estimated losses embedded in the specified credit facility.

 

Economic reserve – This ALLL component reflects anticipated losses impacted by changes in the economic environment. As previously reported, effective January 1, 2004, the company adopted a significantly more quantitative approach to the calculation of the economic reserve component. In order to quantify the economic reserve, the company identified four statistically significant indicators of loss volatility over the seven-year period from 1996 through 2003. The four variables as identified by the regression model are: (1) the US Index of Leading Economic Indicators, (2) the US Corporate Profits Index, (3) the US Unemployment Index, and (4) the University of Michigan Current Consumer Confidence Index.

 

This methodology permits the decomposition of the total ALLL ratio into these three components and provides increased insight into the rationale for increases or decreases in the overall ALLL ratio. As shown in Table 14, the ALLL ratio at June 30, 2004 was 1.32%, of which 0.86% represented the transaction reserve, 0.36% the economic reserve, and 0.10% specific reserves. This analysis shows that of the 7 basis point decline in the ALLL ratio from 1.39% at March 31, 2004, the transaction reserve accounted for 5 basis points. The sale of lower-performing commercial credits during the 2004 second quarter, along with the release of their inherent higher than average transaction reserve component, as well as the change in the overall loan and lease portfolio toward higher credit quality loans, contributed to this decline. The remaining 2 basis points of decline in the ALLL ratio represented lower relative economic reserves, reflecting an improved economic outlook. Specific reserves were unchanged at 10 basis points. This more quantitative methodology for determining the ALLL will be more responsive to changes in the portfolio mix, the economic environment, and to individual credit situations, with the result being an ALLL ratio that exhibits greater quarterly fluctuations.

 

MARKET RISK

 

Market risk is the potential for losses in the fair value of the company’s assets and liabilities due to changes in interest rates, exchange rates, and equity prices. The company incurs market risk in the normal course of business. Market risk arises when the company extends fixed-rate loans, purchases fixed-rate securities, originates fixed-rate certificates of deposit (CDs), obtains funding through fixed-rate borrowings, and leases automobiles and equipment based on expected lease residual values. Market risk arising from changes in interest rates, which affects the market values of fixed-rate assets and liabilities, is interest rate risk. Market risk arising from the possibility that the uninsured residual value of leased assets will be different at the end of the lease term than was estimated at the lease’s inception is residual value risk. From time to time, the company also has small exposures to trading risk and foreign exchange risk. At June 30, 2004, the company had $20.6 million of trading assets, primarily in its broker/dealer businesses.

 

Interest Rate Risk

 

Interest rate risk is the primary market risk incurred by the company. It results from timing differences in the repricing and maturity of assets and liabilities and changes in relationships between market interest rates and the yields on assets and rates on liabilities, including the impact of embedded options.

 

Management seeks to minimize the impact of changing interest rates on the company’s net interest income and the fair value of assets and liabilities. The board of directors establishes broad policies regarding interest rate and market risk and liquidity risk. The asset and liability committee (ALCO) establishes specific operating limits within the parameters of the board of directors’ policies. ALCO regularly monitors position concentrations and the level of interest rate sensitivity to ensure compliance with board of directors approved risk tolerances (see Interest Rate Risk discussion in the company’s 2003 Form 10-K for a complete discussion.)

 

44


Table of Contents

Interest rate risk modeling is performed monthly. Two broad approaches to modeling interest rate risk are employed: income simulation and economic value analysis. An income simulation analysis is used to measure the sensitivity of forecasted net interest income to changes in market rates over a one-year horizon. The economic value analysis (Economic Value of Equity or EVE) is calculated by subjecting the period-end balance sheet to changes in interest rates and measuring the impact of the changes in the value of the assets and liabilities.

 

The simulations for evaluating short-term interest rate risk exposure are scenarios that model gradual 100 and 200 basis point increasing and decreasing parallel shifts in interest rates over the next twelve-month period beyond the interest rate change implied by the current yield curve. The table below shows the results of the scenarios as of June 30, 2004, and March 31, 2004. All of the positions were well within the board of directors’ policy limits.

 

Net Interest Income at Risk (%)

 

Basis point change scenario

   -200     -100     +100     +200  

Board Policy Limits

   -4.0 %   -2.0 %   -2.0 %   -4.0 %
    

 

 

 

June 30, 2004

   N.M.     -0.3 %   -0.0 %   -0.1 %

March 31, 2004

   N.M.     -0.5 %   -0.1 %   -0.3 %

December 31, 2003

   N.M.     -0.3 %   -0.2 %   -0.5 %

N.M., not meaningful.

 

The primary simulations for EVE risk assume an immediate and parallel increase in rates of +/- 100 and +/- 200 basis points beyond any interest rate change implied by the current yield curve. The table below outlines the results compared to the previous quarter and policy limits.

 

Economic Value of Equity at Risk (%)

 

Basis point change scenario

   -200     -100     +100     +200  

Board Policy Limits

   -12.0 %   -5.0 %   -5.0 %   -12.0 %
    

 

 

 

June 30, 2004

   N.M.     +1.5 %   -2.8 %   -6.2 %

March 31, 2004

   N.M.     +0.1 %   -2.7 %   -6.2 %

December 31, 2003

   N.M.     +1.8 %   -3.5 %   -7.9 %

N.M., not meaningful.

 

LIQUIDITY RISK

 

The objective of effective liquidity management is to ensure that cash flow needs can be met on a timely basis at a reasonable cost under both normal operating conditions and unforeseen or unpredictable circumstances. The liquidity of the Bank is available to originate loans and leases and to repay deposit and other liabilities as they become due or are demanded by customers. Liquidity risk arises from the possibility that funds may not be available to satisfy current or future commitments based on external macro market issues, investor perception of financial strength, and events unrelated to the company such as war, terrorism, or financial institution market specific issues (see Liquidity discussion in the company’s 2003 Form 10-K for a complete discussion.)

 

The primary source of funding is core deposits from retail and commercial customers (see Table 15). As of June 30, 2004, core deposits totaled $16.5 billion, and represented 85% of total deposits. This compared with $15.9 billion, or 87% of total deposits, a year earlier. Most of the growth in core deposits was attributable to growth in interest bearing and non-interest bearing demand deposits as retail CDs declined.

 

45


Table of Contents

Table 15 - Deposit Liabilities

 

   

June 30,

2004


   

March 31,

2004


   

December 31,

2003


   

September 30,

2003


   

June 30,

2003


 

(in millions)


  Amount

  %

    Amount

  %

    Amount

  %

    Amount

  %

    Amount

  %

 

By Type

                                                           

Demand deposits

                                                           

Non-interest bearing

  $ 3,327   17.1 %   $ 2,918   15.4 %   $ 2,987   16.2 %   $ 3,003   15.9 %   $ 3,110   16.9 %

Interest bearing

    7,124   36.6       6,866   36.2       6,411   34.7       6,425   34.1       6,332   34.5  

Savings deposits

    3,011   15.5       3,002   15.8       2,960   16.0       3,000   15.9       3,085   16.8  

Retail certificates of deposit

    2,412   12.4       2,395   12.6       2,462   13.3       2,484   13.2       2,739   14.9  

Other domestic time deposits

    595   3.1       608   3.2       631   3.4       638   3.4       664   3.6  
   

 

 

 

 

 

 

 

 

 

Total Core Deposits

    16,470   84.7       15,789   83.2       15,451   83.6       15,550   82.5       15,930   86.7  

Domestic time deposits of $100,000 or more

    808   4.2       791   4.2       789   4.3       844   4.5       826   4.5  

Brokered time deposits and negotiable CDs

    1,679   8.6       1,942   10.2       1,772   9.6       1,837   9.8       1,224   6.7  

Foreign time deposits

    508   2.5       467   2.4       475   2.5       603   3.2       391   2.1  
   

 

 

 

 

 

 

 

 

 

Total Deposits

  $ 19,465   100.0 %   $ 18,989   100.0 %   $ 18,487   100.0 %   $ 18,834   100.0 %   $ 18,371   100.0 %
   

 

 

 

 

 

 

 

 

 

By Business Segment (2)

                                                           

Central Ohio

  $ 4,386   22.5 %   $ 4,378   23.1 %   $ 4,184   22.6 %   $ 4,189   22.3 %   $ 5,045   27.5 %

Northern Ohio

    3,774   19.4       3,517   18.5       3,505   19.0       3,531   18.8       3,529   19.2  

Southern Ohio/Kentucky

    1,559   8.0       1,476   7.8       1,442   7.8       1,437   7.6       1,413   7.7  

West Michigan

    2,599   13.4       2,609   13.7       2,457   13.3       2,529   13.4       2,582   14.1  

East Michigan

    2,081   10.7       2,030   10.7       1,988   10.8       2,000   10.6       2,078   11.3  

West Virginia

    1,369   7.0       1,292   6.8       1,315   7.1       1,324   7.0       1,339   7.3  

Indiana

    668   3.4       637   3.4       648   3.5       661   3.5       640   3.4  
   

 

 

 

 

 

 

 

 

 

Total Regional Banking

    16,435   84.4       15,939   84.0       15,539   84.1       15,671   83.2       16,626   90.5  

Dealer Sales

    71   0.4       77   0.4       77   0.4       65   0.4       68   0.4  

Private Financial Group

    1,016   5.2       1,057   5.6       1,164   6.3       1,117   5.9       1,029   5.6  

Treasury/Other (1)

    1,943   10.0       1,916   10.0       1,707   9.2       1,981   10.5       648   3.5  
   

 

 

 

 

 

 

 

 

 

Total Deposits

  $ 19,465   100.0 %   $ 18,989   100.0 %   $ 18,487   100.0 %   $ 18,834   100.0 %   $ 18,371   100.0 %
   

 

 

 

 

 

 

 

 

 


(1) Comprised largely of brokered deposits and negotiable CDs.
(2) Prior period amounts have been reclassified to conform to the current period business segment structure.

 

Liquidity policies and limits are established by the board of directors, with operating limits set by ALCO. Two primary liquidity measures are the ratio of loans and operating lease assets to deposits and the percentage of assets funded with non-core, or wholesale, liabilities. The limits set by the board for these two liquidity measures are 135% and 40%, respectively. At June 30, 2004, the actual ratio of loans and operating leases to deposits was 116%, while the percentage of assets funded with non-core or wholesale liabilities was 35%. In addition, guidelines are established by ALCO to ensure diversification of wholesale funding by type, source, and maturity and provide sufficient balance sheet liquidity to cover 100% of wholesale funds maturing within a six-month time period. A contingency funding plan is in place, which includes forecasted sources and uses of funds under various scenarios in order to prepare for unexpected liquidity shortages, including the implications of any rating agency changes. ALCO meets monthly to identify and monitor liquidity issues, provide policy guidance, and oversee adherence to, and the maintenance of, an evolving contingency funding plan.

 

Credit ratings by the three major credit rating agencies are an important component of the company’s liquidity profile. Among other factors, the credit ratings are based on the financial strength, credit quality and concentrations in the loan portfolio, the level and volatility of earnings, capital adequacy, the quality of management, the liquidity of the balance sheet, the availability of a significant base of core retail and commercial deposits, and the company’s ability to access a broad array of wholesale funding sources. Adverse changes in these factors could result in a negative change in credit ratings and impact not only the ability to raise funds in the capital markets, but also the cost of these funds. In addition, certain financial on- and off-balance sheet arrangements contain credit rating triggers that could increase funding needs if a negative rating change occurs. Letter of credit commitments for marketable securities, interest rate swap collateral agreements, and certain asset securitization transactions contain credit rating provisions.

 

46


Table of Contents

As a result of the formal SEC investigation announced June 26, 2003, Standard and Poor’s rating agency placed the company’s debt ratings on “CreditWatch Negative”. On April 15, 2004, Standard and Poor’s removed the company’s debt rating from “CreditWatch Negative” and revised the outlook to “Stable” from “Negative.” Credit ratings are as follows:

 

    

Senior

Unsecured

Notes


  

Subordinated

Notes


  

Short

Term


   Outlook

Huntington Bancshares Incorporated

                   

Moody’s Investor Service

   A2    A3    P1    Negative

Standard and Poor’s

   A-    BBB+    A2    Stable

Fitch Ratings

   A    A-    F1    Stable

The Huntington National Bank

                   

Moody’s Investor Service

   A1    A2    P1    Negative

Standard and Poor’s

   A    A-    A1    Stable

Fitch Ratings

   A    A-    F1    Stable

 

Management believes that sufficient liquidity exists to meet the funding needs of the Bank and the parent company.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

Like other financial organizations, Huntington has various commitments in the ordinary course of business that, under GAAP, are not recorded in the financial statements. Specifically, Huntington makes various commitments to extend credit to customers, to sell loans, and to maintain obligations under operating-type non-cancelable leases for its facilities. Derivatives and other off-balance sheet arrangements are discussed under the “Market Risk” section of the company’s 2003 Form 10-K.

 

Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. There were $962 million of outstanding standby letters of credit at June 30, 2004. Non-interest income was recognized from the issuance of these standby letters of credit of $2.8 million for the period ended June 30, 2004. The carrying amount of deferred revenue related to standby letters of credit at June 30, 2004, was $3.2 million. Standby letters of credit are included in the determination of the amount of risk-based capital that the company and the Bank are required to hold.

 

CAPITAL

 

Capital is managed both at the parent and the Bank levels. Capital levels are maintained based on regulatory capital requirements and the economic capital required to support credit, market, and operation risks inherent in the company’s business and to provide the flexibility needed for future growth and new business opportunities. Management places significant emphasis on the maintenance of a strong capital position, which promotes investor confidence, provides access to the national markets under favorable terms, and enhances business growth and acquisition opportunities. The importance of managing capital is also recognized, and Management continually strives to maintain an appropriate balance between capital adequacy and providing attractive returns to shareholders.

 

Shareholders’ equity totaled $2.4 billion at June 30, 2004. This balance represented a $111 million increase from December 31, 2003. The growth in shareholders’ equity resulted from the retention of net income after dividends to shareholders of $134 million and stock option exercises of $7 million. The growth was offset by a decrease in accumulated other comprehensive income of $30 million. The decrease in accumulated other comprehensive income primarily resulted from a decline in the market value of securities available for sale, partially offset by an increase in the market value of cash flow hedges at June 30, 2004, compared with December 31, 2003.

 

At June 30, 2004, the company had unused authority to repurchase up to 7.5 million shares. On September 4, 2001, options totaling 3.2 million shares were granted to all employees, the vesting of which occurs on September 4, 2006, or earlier should Huntington’s common stock closing price for five consecutive trading days be at or

 

47


Table of Contents

above $25.00. Huntington’s common stock price closed at $25.07 on August 2, 2004, thus increasing the possibility that the remaining 2.2 million options outstanding at June 30, 2003, may vest in the near future. Should that occur, there is also the possibility that a portion of the current stock repurchase authorization would be used to help mitigate the dilutive earnings impact resulting from the issuance of these shares. These, and any additional purchases including the 2.5 million shares associated with the Unizan merger, will be made from time-to-time in the open market or through privately negotiated transactions depending on market conditions.

 

On July 16, 2004, the board of directors declared a quarterly cash dividend on its common stock of $0.20 per common share, up 14.3% from the current quarterly dividend of $0.175 per common share. The dividend is payable October 1, 2004, to shareholders of record on September 17, 2004.

 

Table 16 - Quarterly Common Stock Summary

 

     2004

   2003

     Second

   First

   Fourth

   Third

   Second

Common Stock Price

                                  

High (1)

   $ 23.120    $ 23.780    $ 22.550    $ 20.890    $ 21.540

Low (1)

     20.890      21.000      19.850      19.220      18.030

Close

     22.980      22.030      22.500      19.850      19.510

Average closing price

     22.050      22.501      21.584      20.199      19.790

Book value per share

   $ 10.40    $ 10.31    $ 9.93    $ 9.79    $ 9.63

Dividends

                                  

Cash dividends declared

   $ 0.175    $ 0.175    $ 0.175    $ 0.175    $ 0.160

Common shares outstanding (000s)

                                  

Average — Basic

     229,429      229,227      228,902      228,715      228,633

Average — Diluted

     232,659      232,915      231,986      230,966      230,572

Ending

     229,476      229,410      229,008      228,870      228,660

Common Share Repurchase Program (000s)

                                  

Number of Shares Repurchased

     —        —        —        —        —  

(1) High and low stock prices are intra-day quotes obtained from NASDAQ.

 

Average equity to average assets in the 2004 second quarter was 7.42%, down from 7.66% a year earlier, but up from 7.39% for the first quarter of 2004 (see Table 17). At June 30, 2004, the tangible equity to assets ratio was 6.95%, down from 7.06% a year ago, and from 6.97% March 31, 2004. The decline from the year-ago period primarily reflected the impact of the 2003 third quarter adoption of FIN 46, which resulted in the consolidation of $1.0 billion of securitized automobile loans, partially offset by earnings-related growth in capital. The increase from March 31, 2004, primarily reflected growth in retained earnings.

 

Table 17 - Capital Adequacy

 

     Three Months Ended

 

(in millions)


   June 30,
2004


    March 31
2004


    December 31,
2003


    September 30,
2003


    June 30,
2003


 

Total Risk-Adjusted Assets

   $ 28,413     $ 28,236     $ 28,164     $ 27,949     $ 27,456  

Tier 1 Risk-Based Capital Ratio

     9.00 %     8.74 %     8.53 %     8.40 %     8.32 %

Total Risk-Based Capital Ratio

     12.58 %     12.38 %     11.95 %     11.19 %     11.11 %

Tier 1 Leverage Ratio

     8.22 %     8.08 %     7.98 %     7.94 %     8.25 %

Tangible Equity / Assets Ratio

     6.95 %     6.97 %     6.79 %     6.77 %     7.06 %

Tangible Equity / Risk-Weighted Assets Ratio

     7.64 %     7.61 %     7.30 %     7.24 %     7.23 %

Average equity / average assets

     7.42 %     7.39 %     7.32 %     7.49 %     7.66 %

 

48


Table of Contents

At June 30, 2004, the tangible equity to risk-weighted assets ratio was 7.64%, up significantly from 7.23% in the year-ago quarter, and up from 7.61% at March 31, 2004. The increase in the tangible equity to risk-weighted assets ratio reflected primarily the positive impact resulting from reducing the overall risk profile of earning assets throughout this period, most notably a less risky loan portfolio mix, as well as growth in low risk investment securities.

 

The Federal Reserve Board, which supervises and regulates the company, sets minimum capital requirements for each of these regulatory capital ratios. In the calculation of these risk-based capital ratios, risk weightings are assigned to certain asset and off-balance sheet items such as interest rate swaps, loan commitments, and securitizations. Huntington’s Tier 1 Risk-based Capital, Total Risk-based Capital, Tier 1 Leverage ratios, and risk-adjusted assets for the recent five quarters are well in excess of minimum levels established for “well capitalized” institutions of 6.00%, 10.00%, and 5.00%, respectively. At June 30, 2004, the company had regulatory capital ratios in excess of “well capitalized” regulatory minimums.

 

The Bank is primarily supervised and regulated by the Office of the Comptroller of the Currency, which establishes regulatory capital guidelines for banks similar to those established for bank holding companies by the Federal Reserve Board. At June 30, 2004, the Bank had regulatory capital ratios in excess of “well capitalized” regulatory minimums.

 

LINES OF BUSINESS DISCUSSION

 

Huntington has three distinct lines of business: Regional Banking, Dealer Sales, and the Private Financial Group (PFG). A fourth segment includes the company’s Treasury functions and capital markets activities and other unallocated assets, liabilities, revenue, and expense. Lines of business results are determined based upon the company’s management reporting system, which assigns balance sheet and income statement items to each of the business segments. A description of each segment and discussion of financial results is provided below.

 

Management uses earnings on an operating basis, rather than on a GAAP basis, to measure underlying performance trends for each business segment. Operating earnings represent GAAP earnings adjusted to exclude the impact of the significant items discussed in Note 8 to the Condensed Consolidated Financial Statements. Analyzing earnings on an operating basis is very helpful in assessing underlying performance trends, a critical factor used by Management to determine the success of strategies and future earnings capabilities.

 

Regional Banking

 

Regional Banking provides products and services to retail, business banking, and commercial customers. These products and services are offered in seven operating regions within the five states of Ohio, Michigan, West Virginia, Indiana, and Kentucky through the company’s traditional banking network. Each region is further divided into Retail and Commercial Banking units. Retail products and services include home equity loans and lines of credit, first mortgage loans, direct installment loans, business loans, personal and business deposit products, as well as sales of investment and insurance services. Retail products and services comprise 57% and 81% of total Regional Banking loans and deposits, respectively. These products and services are delivered to customers through banking offices, ATMs, Direct Bank—Huntington’s customer service center, and Web Bank at huntington.com. Commercial banking serves middle-market and commercial banking relationships, which use a variety of banking products and services including, commercial loans, international trade, cash management, leasing, interest rate protection products, capital market alternatives, 401(k) plans, and mezzanine investment capabilities.

 

2004 Second Quarter versus 2003 Second Quarter

 

Regional banking contributed $60.9 million of the company’s net operating earnings in the second quarter of 2004, up $35.9 million from the second quarter of 2003. This increase primarily reflected a $44.5 million reduction in provision for credit losses. Also benefiting comparisons with the year-ago quarter was a $15.3 million, or 7%, growth in revenue, reflecting a $4.7 million, or 3%, increase in net interest income and $10.7 million, or 15%, increase in non-interest income. The benefits of lower provision for credit losses and higher revenue from the year-ago quarter were partially offset by expense growth of $4.5 million, or 3%. The ROA in the 2004 second quarter was 1.52%, up from 0.69% in the year-ago quarter. The ROE was 23.9% in the current quarter, up from 9.8% in the 2003 second quarter.

 

Compared with the year-ago quarter, 2004 second quarter net interest income increased $4.7 million, or 3%, reflecting a 14% increase in average total loans and 5% increase in average total deposits, partially offset by a 28 basis point decline in net interest margin to 4.15% from 4.43%.

 

49


Table of Contents

Average total loans increased $1.8 billion, or 14%, primarily reflecting a $1.0 billion, or 66%, increase in average residential mortgages, a $0.7 billion, or 24%, increase in home equity loans and lines of credit, as well as a $0.3 billion, or 10%, increase in average CRE loans. The growth in home equity, residential mortgages, and CRE loans reflected the favorable impact of low interest rates on demand for real estate-related financing. In addition, the launch of a new Consumer First Mortgage, targeted at high convenience, low loan-to-value ratio borrowers, accounted for $0.3 billion of the $0.7 billion increase in average home equity loans and lines of credit. Total average C&I loans declined $0.3 billion, or 7%, from the year-ago quarter. The decline in C&I loans was due in part to weak demand, as well as the impact from continued strategies to lower exposure to large individual commercial credits, including shared national credits. Small Business C&I and CRE loans (included in total average C&I and CRE loans) increased $0.2 billion, or 11%, due to specific strategies that focus on this business segment.

 

Average total deposits increased $0.8 billion, or 5%. This reflected strong growth in average interest bearing demand deposits, up $1.0 billion, or 19%, and a $0.1 billion, or 5%, increase in non-interest bearing deposits, which was partially offset by a $0.5 billion, or 12%, decline in domestic time deposits. Of the $0.8 billion increase in average total deposits, Corporate Banking accounted for $0.6 billion and Small Business $0.4 billion, with average total deposits in Retail Banking declining $0.1 billion.

 

The company continued to focus on customer service and delivery channel optimization. From the year-ago quarter, eight banking offices were opened while nine were closed. Progress was made in improving the Retail Banking 90-day cross sell ratio, from 1.9 products or services to 2.2, a 19% improvement. Further, the online banking penetration of retail households with on-line banking increased to 35% from 26% a year earlier, with a 37% increase in the number of online customers.

 

The 28 basis points, or an effective 6%, decline in the net interest margin to 4.15% from 4.43% reflected a combination of factors. This included a shift in the loan portfolio mix to lower-margin, but higher credit quality, consumer residential real estate-related loans. In addition, interest rates offered on deposits have been near historical lows throughout this period, and as rates continued to fall from a year-ago, it was increasingly difficult to make commensurate reductions in deposit rates compared with reductions in loan yields.

 

Provision for credit losses for the second quarter of 2004 represented a credit of $3.9 million, or $44.5 million less than in the year-ago quarter. This decline reflected the overall improvement in credit quality, as well as the shift to lower-rate, lower-risk residential mortgages and home equity loans and lines. Net charge-offs were only $1.8 million, or an annualized 0.05% of average loans and leases, down from $31.6 million, or 0.97%, in the year-ago quarter. The 2004 second quarter net charge-offs were reduced by a $9.7 million C&I recovery on a single credit charged-off in the 2002 fourth quarter (see Credit Risk for additional discussion regarding charge-offs and allowance for loan loss reserve methodologies).

 

Non-interest income increased $10.7 million, or 15%, from the year-ago quarter, reflecting a combination of factors including higher mortgage banking income, an increase in deposit service charges, growth in brokerage and insurance income, and an increase in other income, partially offset by a decline in other service charges and fees.

 

Mortgage banking income increased $6.2 million, or 89%, from the year-ago quarter largely as a result of a change in reporting methodology. In 2004, MSR impairment and recovery is reflected in the Treasury/Other segment, whereas in the year-ago quarter MSR impairment of $6.4 million was reflected in Regional Banking. Deposit service charges increased $2.7 million, or 7%, reflecting higher personal NSF and overdraft fees. The $1.6 million, or 16%, increase in other income was due primarily to the full year impact of the 2003 adoption of FIN 45 for standby letters of credit, which recognizes fees over the life of the related guarantee, rather than at the time of quarterly or annual billings. Brokerage and insurance income increased $0.7 million, or 18%, due to higher credit protection insurance fees. The $0.7 million, or 7%, decline in other service charges and fees reflected lower interchange fees on debit card transactions.

 

Non-interest expense increased $4.5 million, or 3%, from the year-ago quarter. Higher personnel costs contributed $2.0 million to this increase due to an increase in the number of employees, as well as higher benefit costs. The $2.3 million, or 3%, increase in other expenses reflected higher occupancy, printing and supplies, depreciation, and outside servicing expenses, partially offset by lower marketing, telecommunications, legal and professional, and transportation expenses.

 

50


Table of Contents

2004 Second Quarter versus 2004 First Quarter

 

Regional Banking earnings in the 2004 second quarter increased $12.8 million, or 27%, from the 2004 first quarter. This reflected a $14.4 million, or 6%, increase in revenue as non-interest income increased $10.4 million, or 14%, and net interest income increased $4.0 million, or 3%. Also contributing to the increase in earnings was a $6.1 million reduction in provision for credit losses. The benefits of higher revenue and lower provision for credit losses were partially offset by a slight increase in non-interest expense. The ROA in the 2004 second quarter was 1.52%, up from 1.27% in the 2004 first quarter, with the ROE of 23.9%, up from 19.2% in the prior quarter.

 

Net interest income increased $4.0 million, or 3%, from the prior quarter, reflecting growth in average total loans and deposits, partially offset by a decline in the net interest margin to 4.15% from 4.25%.

 

Average total loans increased $0.7 billion, or 5%. Consumer loans increased 10%, reflecting strong growth in residential mortgages and home equity loans and lines of credit. Average C&I loans increased 2% with CRE loans increasing 1%. The growth in average C&I loans is encouraging and may reflect the positive impact of a recovering economy. Total average deposits increased $0.7 billion, or 5%, reflecting strong growth in interest bearing and non-interest bearing demand deposits, up 10% and 7%, respectively.

 

From the end of the 2004 first quarter, the number of demand deposit account (DDA) households increased 1%, and the 90-day cross sell ratio of 2.2 products was unchanged. On-line banking penetration of retail households increased to 35% from 34%, and the number of active online users increased 5%.

 

The $6.1 million decline in provision for credit losses from the first quarter reflected the combination of improved credit quality performance and improved economic outlook, as well as the continued lowering of the overall credit risk profile of the loan portfolio through the growth in residential real estate-related loans. Net charge offs were $1.8 million, or an annualized 0.05% of average loans and leases in the current quarter, down from $11.6 million, or 0.33%, in the first quarter, primarily attributable to the $9.7 million C&I recovery in the current quarter.

 

Non-interest expense increased $0.7 million from the first quarter of 2004. This increase was largely due to a $1.9 million increase in other expenses, as personnel expense declined $1.4 million. The increase in other expenses reflected higher other real estate owned expenses, low income housing investment amortization, printing and supplies costs, and operating losses. Personnel expense declined due to higher FASB 91 deferred salary costs associated with higher loan production.

 

2004 First Six Months versus 2003 First Six Months

 

Regional banking contributed $108.9 million of the company’s net operating earnings in the first six months of 2004, up $48.8 million from the comparable year-ago period. This increase primarily reflected a $65.9 million reduction in provision for credit losses. Also benefiting comparisons with the year-ago period was a $20.3 million, or 5%, growth in revenue, reflecting a $9.3 million, or 3%, increase in net interest income and $11.1 million, or 8%, increase in non-interest income. The benefits of lower provision for credit losses and higher revenue from the year-ago period were partially offset by expense growth of $11.3 million, or 4%. The ROA in the first six months of 2004 was 1.39%, up from 0.85% in the year-ago period. The ROE was 21.5% in the first six months, up from 12.1% in the comparable 2003 period.

 

Net interest income in the first six months of 2004 increased $9.3 million, or 3%, reflecting a 12% increase in average total loans and 4% increase in average total deposits, partially offset by a 27 basis point decline in net interest margin to 4.19% from 4.45%.

 

Average total loans increased $1.5 billion, or 12%, primarily reflecting a $0.8 billion, or 57%, increase in average residential mortgages, a $0.7 billion, or 22%, increase home equity loans and lines of credit, as well as a $0.4 billion, or 11%, increase in average CRE loans. Total average C&I loans declined $0.4 million, or 8%, from the year-ago six-month period. The growth in home equity, residential mortgages, and CRE loans, as well as the decline in C&I loans reflected the same factors noted above in the year-ago quarter. Small Business C&I and CRE loans (included in total average C&I and CRE loans) increased $0.2 billion, or 11%, due to specific strategies that focus on this business segment.

 

Average total deposits increased $0.6 billion, or 4%. This reflected strong growth in average interest bearing demand deposits, up $0.9 billion, or 18%, partially offset by a $0.5 billion, or 13%, decline in domestic time deposits. Of the $0.6 billion increase in average total deposits, Corporate Banking accounted for $0.6 billion and Small Business $0.3 billion, with average total Consumer deposits declining $0.3 billion.

 

51


Table of Contents

The 27 basis points, or an effective 6%, decline in the net interest margin to 4.19% from 4.45% reflected the same factors discussed above in the 2004 second quarter versus 2003 second quarter performance.

 

Provision for credit losses for the first six months of 2004 represented a credit of $1.8 million, or $65.9 million less than in the year-ago period. This decline reflected the overall improvement in credit quality, as well as the shift to lower risk residential mortgages and home equity loans and lines. Net charge-offs were only $13.4 million, or an annualized 0.19% of average loans and leases, down from $51.9 million, or 0.81% in the comparable year-ago period. The 2004 first-half net charge-offs were reduced by a $9.7 million C&I recovery (see Credit Risk for additional discussion regarding charge-offs and allowance for loan loss reserve methodologies).

 

Non-interest income for the first six months of 2004 increased $11.1 million, or 8%, from the comparable year-ago period, reflecting a combination of factors including higher other income, an increase in deposit service charges, and higher mortgage banking revenue, partially offset by a decline in other service charges and fees.

 

The $5.8 million, or 34%, increase in other income from the comparable year-ago six-month period was due primarily to the full year impact of the FIN 45 adjustment discussed above, and $2.3 million of other fees. Deposit service charges increased $4.7 million, or 6%, reflecting higher personal NSF and overdraft fees. Mortgage banking income increased $1.3 million, or 7%, from the year-ago period largely as a result of a change in reporting methodology. In 2004, MSR impairment and recovery is reflected in the Treasury/Other segment, whereas in the comparable year-ago six month period MSR impairment of $6.4 million was reflected in Regional Banking. This was partially offset by changes in origination income, marketing income and MSR amortization, as a result of changes in the interest rate environment. The $1.6 million, or 7%, decline in other service charges and fees reflected lower interchange fees on debit card transactions.

 

Non-interest expense for the first six months of 2004 increased $11.3 million, or 4%, from the year-ago period. Higher personnel costs contributed $5.7 million to this increase due to a 3% increase in the number of employees, as well as higher benefit costs. The $5.3 million, or 3%, increase in other expenses reflected higher marketing, depreciation, printing and supplies, and charge card processing expenses, partially offset by lower telecommunication, legal and professional, and transportation expenses.

 

52


Table of Contents

Table 18 - Regional Banking(1)

 

    2004

    2004

  2003

  2Q04 vs. 2Q03

    2004

    2003

  1H04 vs. 1H03

 
    Second

    First

  Second

  Amount

    %

    6 Months

    6 Months

  Amount

    %

 

INCOME STATEMENT (in thousands)

                                                             

Net Interest Income

  $ 155,083     $ 151,062   $ 150,418   $ 4,665     3.1 %   $ 306,145     $ 296,832   $ 9,313     3.1 %

Provision for credit losses

    (3,949 )     2,105     40,525     (44,474 )   NM       (1,844 )     64,078     (65,922 )   NM  
   


 

 

 


 

 


 

 


 

Net Interest Income After Provision for Credit Losses

    159,032       148,957     109,893     49,139     44.7 %     307,989       232,754     75,235     32.3 %
   


 

 

 


 

 


 

 


 

Operating lease income

    327       49     —       327     NM       376       —       376     NM  

Service charges on deposit accounts

    42,357       40,703     39,707     2,650     6.7 %     83,060       78,371     4,689     6.0 %

Brokerage and insurance income

    4,515       3,856     3,842     673     17.5 %     8,371       7,843     528     6.7 %

Trust services

    225       292     280     (55 )   -19.6 %     517       548     (31 )   -5.7 %

Mortgage banking

    13,227       6,033     6,997     6,230     89.0 %     19,260       17,941     1,319     7.4 %

Other service charges and fees

    10,529       9,413     11,259     (730 )   -6.5 %     19,942       21,499     (1,557 )   -7.2 %

Other

    11,295       11,705     9,705     1,590     16.4 %     23,000       17,187     5,813     33.8 %
   


 

 

 


 

 


 

 


 

Total Non-Interest Income Before Securities Gains

    82,475       72,051     71,790     10,685     14.9 %     154,526       143,389     11,137     7.8 %

Securities gains

    —         —       —       —       NM       —         —       —       NM  
   


 

 

 


 

 


 

 


 

Total Non-Interest Income

    82,475       72,051     71,790     10,685     14.9 %     154,526       143,389     11,137     7.8 %
   


 

 

 


 

 


 

 


 

Operating lease expense

    275       44     —       275     NM       319       —       319     NM  

Personnel costs

    61,728       63,156     59,761     1,967     3.3 %     124,884       119,193     5,691     4.8 %

Other

    85,837       83,892     83,558     2,279     2.7 %     169,729       164,430     5,299     3.2 %
   


 

 

 


 

 


 

 


 

Total Non-Interest Expense

    147,840       147,092     143,319     4,521     3.2 %     294,932       283,623     11,309     4.0 %
   


 

 

 


 

 


 

 


 

Income Before Provision for Income Taxes

    93,667       73,916     38,364     55,303     NM       167,583       92,520     75,063     81.1 %

Provision for income taxes (2)

    32,783       25,871     13,427     19,356     NM       58,654       32,382     26,272     81.1 %
   


 

 

 


 

 


 

 


 

Net Income - Operating (1)

  $ 60,884     $ 48,045   $ 24,937   $ 35,947     NM     $ 108,929     $ 60,138   $ 48,791     81.1 %
   


 

 

 


 

 


 

 


 

Revenue - Fully Taxable Equivalent (FTE)

                                                             

Net interest income

  $ 155,083     $ 151,062   $ 150,418   $ 4,665     3.1 %   $ 306,145     $ 296,832   $ 9,313     3.1 %

Tax equivalent adjustment (2)

    250       249     311     (61 )   -19.6 %     499       642     (143 )   -22.3 %
   


 

 

 


 

 


 

 


 

Net interest income (FTE)

    155,333       151,311     150,729     4,604     3.1 %     306,644       297,474     9,170     3.1 %

Non-interest income

    82,476       72,051     71,790     10,686     14.9 %     154,527       143,389     11,138     7.8 %
   


 

 

 


 

 


 

 


 

Total Revenue (FTE)

  $ 237,809     $ 223,362   $ 222,519   $ 15,290     6.9 %   $ 461,171     $ 440,863   $ 20,308     4.6 %
   


 

 

 


 

 


 

 


 

Total Revenue Excluding Securities Gains (FTE)

  $ 237,809     $ 223,362   $ 222,519   $ 15,290     6.9 %   $ 461,171     $ 440,863   $ 20,308     4.6 %
   


 

 

 


 

 


 

 


 

SELECTED AVERAGE BALANCES (in millions)

                                                             

Loans:

                                                             

C&I

  $ 4,287     $ 4,219   $ 4,590   $ (303 )   -6.6 %   $ 4,253     $ 4,631   $ (378 )   -8.2 %

CRE

                                                             

Construction

    1,297       1,290     1,211     86     7.1 %     1,292       1,171     121     10.3 %

Commercial

    2,591       2,567     2,335     256     11.0 %     2,578       2,300     278     12.1 %

Consumer

                                                             

Auto loans - indirect

    5       5     7     (2 )   -28.6 %     5       7     (2 )   -28.6 %

Home equity loans & lines of credit

    3,848       3,593     3,109     739     23.8 %     3,720       3,053     667     21.8 %

Residential mortgage

    2,474       2,163     1,489     985     66.2 %     2,318       1,480     838     56.6 %

Other loans

    317       278     315     2     0.6 %     297       320     (23 )   -7.2 %
   


 

 

 


 

 


 

 


 

Total Consumer

    6,644       6,039     4,920     1,724     35.0 %     6,340       4,860     1,480     30.5 %
   


 

 

 


 

 


 

 


 

Total Loans

  $ 14,819     $ 14,115   $ 13,056   $ 1,763     13.5 %   $ 14,463     $ 12,962   $ 1,501     11.6 %
   


 

 

 


 

 


 

 


 

Deposits:

                                                             

Non-interest bearing deposits

  $ 2,982     $ 2,783   $ 2,850   $ 132     4.6 %   $ 2,882     $ 2,787   $ 95     3.4 %

Interest bearing demand deposits

    6,454       5,854     5,432     1,022     18.8 %     6,154       5,222     932     17.8 %

Savings deposits

    2,790       2,773     2,749     41     1.5 %     2,781       2,737     44     1.6 %

Domestic time deposits

    3,689       3,728     4,184     (495 )   -11.8 %     3,709       4,249     (540 )   -12.7 %

Foreign time deposits

    420       423     325     95     29.2 %     421       314     107     34.1 %
   


 

 

 


 

 


 

 


 

Total Deposits

  $ 16,335     $ 15,561   $ 15,540   $ 795     5.1 %   $ 15,947     $ 15,309   $ 638     4.2 %
   


 

 

 


 

 


 

 


 


(1) Operating basis, see page 50 for definition.
(2) Calculated assuming a 35% tax rate.
NM, not a meaningful value.

 

53


Table of Contents

Table 18 - Regional Banking(1)

 

    2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

    1H04 vs. 1H03

 
    Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

    Amount

    %

 

PERFORMANCE METRICS

                                                                   

Return on average assets

    1.52 %     1.27 %     0.69 %     0.83 %           1.39 %     0.85 %     0.55 %      

Return on average equity

    23.9 %     19.2 %     9.8 %     14.1 %           21.5 %     12.1 %     9.5 %      

Net interest margin

    4.15 %     4.25 %     4.43 %     -0.28 %           4.19 %     4.45 %     -0.27 %      

Efficiency ratio

    62.2 %     65.9 %     64.4 %     -2.2 %           64.0 %     64.3 %     -0.4 %      

CREDIT QUALITY

                                                                   

Net Charge-offs by Loan Type (in thousands)

                                                                   

C&I

  $ (3,656 )   $ 5,939     $ 26,213     $ (29,869 )   NM     $ 2,283     $ 40,853     $ (38,570 )   -94.4 %

CRE

    941       1,636       605       336     55.5 %     2,577       1,151       1,426     NM  
   


 


 


 


 

 


 


 


 

Total commercial

    (2,715 )     7,575       26,818       (29,533 )   NM       4,860       42,004       (37,144 )   -88.4 %

Consumer

                                                                   

Auto loans

    40       (21 )     34       6     17.6 %     19       23       (4 )   -17.4 %

Home equity loans & lines of credit

    3,019       2,956       3,609       (590 )   -16.3 %     5,975       7,463       (1,488 )   -19.9 %

Residential mortgage

    302       316       267       35     13.1 %     618       391       227     58.1 %

Other loans

    1,196       778       819       377     46.0 %     1,974       2,055       (81 )   -3.9 %
   


 


 


 


 

 


 


 


 

Total consumer

    4,557       4,029       4,729       (172 )   -3.6 %     8,586       9,932       (1,346 )   -13.6 %
   


 


 


 


 

 


 


 


 

Total Net Charge-offs

  $ 1,842     $ 11,604     $ 31,547     $ (29,705 )   -94.2 %   $ 13,446     $ 51,936     $ (38,490 )   -74.1 %
   


 


 


 


 

 


 


 


 

Net Charge-offs - annualized percentages

                                                                   

C&I

    -0.34 %     0.57 %     2.29 %     -2.63 %           0.11 %     1.78 %     -1.67 %      

CRE

    0.10 %     0.17 %     0.07 %     0.03 %           0.13 %     0.07 %     0.07 %      
   


 


 


 


 

 


 


 


 

Total commercial

    -0.13 %     0.38 %     1.32 %     -1.45 %           0.12 %     1.05 %     -0.93 %      

Consumer

                                                                   

Auto loans

    3.22 %     -1.69 %     1.95 %     1.27 %           0.76 %     0.66 %     0.10 %      

Home equity loans & lines of credit

    0.32 %     0.33 %     0.47 %     -0.15 %           0.32 %     0.49 %     -0.17 %      

Residential mortgage

    0.05 %     0.06 %     0.07 %     -0.02 %           0.05 %     0.05 %     0.00 %      

Other loans

    1.52 %     1.13 %     1.04 %     0.48 %           1.33 %     1.30 %     0.04 %      
   


 


 


 


 

 


 


 


 

Total consumer

    0.28 %     0.27 %     0.39 %     -0.11 %           0.27 %     0.41 %     -0.14 %      
   


 


 


 


 

 


 


 


 

Total Net Charge-offs

    0.05 %     0.33 %     0.97 %     -0.92 %           0.19 %     0.81 %     -0.62 %      
   


 


 


 


 

 


 


 


 

Non-Performing Assets (NPA) (in millions)

                                                                   

C&I

  $ 30     $ 42     $ 84     $ (54 )   -64.3 %   $ 30     $ 84     $ (54 )   -64.3 %

CRE

    7       9       22       (15 )   -68.2 %     7       22       (15 )   -68.2 %

Residential mortgage

    11       11       11       —       0.0 %     11       11       —       0.0 %
   


 


 


 


 

 


 


 


 

Total Non-accrual Loans

    48       62       117       (69 )   -59.0 %     48       117       (69 )   -59.0 %

Renegotiated loans

    —         —         —         —       NM       —         —         —       NM  
   


 


 


 


 

 


 


 


 

Total Non-performing Loans (NPL)

    48       62       117       (69 )   -59.0 %     48       117       (69 )   -59.0 %

Other real estate, net (OREO)

    14       16       14       —       0.0 %     14       14       —       0.0 %
   


 


 


 


 

 


 


 


 

Total Non-performing Assets

  $ 62     $ 78     $ 131     $ (69 )   -52.7 %   $ 62     $ 131     $ (69 )   -52.7 %
   


 


 


 


 

 


 


 


 

Accruing loans past due 90 days or more (eop)

  $ 41     $ 47     $ 40     $ 1     2.5 %   $ 41     $ 40     $ 1     2.5 %

Allowance for Loan and Lease Losses (ALLL) (eop)

  $ 186     $ 158     $ 199     $ (13 )   -6.5 %   $ 186     $ 199     $ (13 )   -6.5 %

ALLL as a % of total loans and leases

    1.22 %     1.10 %     1.52 %     -0.30 %           1.22 %     1.52 %     -0.30 %      

ALLL as a % of NPLs

    387.5 %     254.8 %     170.1 %     217.4 %           387.5 %     170.1 %     217.4 %      

ALLL + OREO as a% of NPAs

    322.6 %     223.1 %     162.6 %     160.0 %           322.6 %     162.6 %     160.0 %      

NPLs as a % of total loans and leases

    0.31 %     0.43 %     0.90 %     -0.59 %           0.31 %     0.90 %     -0.59 %      

NPAs as a % of total loans and leases + OREO

    0.40 %     0.54 %     1.00 %     -0.60 %           0.40 %     1.00 %     -0.60 %      

(1) Operating basis, see page 50 for definition.
NM, not a meaningful value.
eop, end of period.

 

 

54


Table of Contents

Table 18 - Regional Banking(1)

 

    2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

    1H04 vs. 1H03

 
    Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

    Amount

    %

 

SUPPLEMENTAL DATA

                                                                   

# employees - full-time equivalent (eop)

    4,953       4,823       4,834       119     2.5 %     4,953       4,834       119     2.5 %

Retail Banking

                                                                   

Average loans (in millions)

  $ 4,545     $ 4,236     $ 3,694     $ 851     23.0 %   $ 4,385     $ 3,645     $ 740     20.3 %

Average deposits (in millions)

  $ 11,025     $ 10,680     $ 11,174     $ (149 )   -1.3 %   $ 10,851     $ 11,116     $ (265 )   -2.4 %

# employees - full-time equivalent (eop)

    3,510       3,392       3,378       132     3.9 %     3,510       3,378       132     3.9 %

# banking offices (eop)

    335       332       336       (1 )   -0.3 %     335       336       (1 )   -0.3 %

# ATMs (eop)

    700       684       855       (155 )   -18.1 %     700       855       (155 )   -18.1 %

# DDA households (eop)

    494,960       491,949       493,219       1,741     0.4 %     494,960       493,219       1,741     0.4 %

# New 90-day cross sell (average)(3)

    2.2       2.2       1.9       0.4     18.9 %     2.2       1.8       0.4     22.2 %

# on-line customers (eop)

    185,454       179,681       136,700       48,754     35.7 %     185,454       136,700       48,754     35.7 %

% on-line retail household penetration (eop)

    35 %     34 %     26 %     9 %           35 %     26 %     9 %      

Small Business

                                                                   

Average loans (in millions)

  $ 1,865     $ 1,824     $ 1,684     $ 181     10.7 %   $ 1,845     $ 1,660     $ 185     11.1 %

Average deposits (in millions)

  $ 1,980     $ 1,844     $ 1,620     $ 360     22.2 %   $ 1,912     $ 1,585     $ 327     20.6 %

# employees - full-time equivalent (eop)

    260       260       252       8     3.2 %     260       252       8     3.2 %

# customers (eop)

    64,558       63,440       68,756       (4,198 )   -6.1 %     64,558       68,756       (4,198 )   -6.1 %

# New 90-day cross sell (average) (4)

    2.2       2.1       1.8       0.4     20.2 %     2.1       1.8       0.3     16.7 %

Corporate Banking

                                                                   

Average loans (in millions)

  $ 6,377     $ 6,316     $ 6,505     $ (128 )   -2.0 %   $ 6,347     $ 6,495     $ (148 )   -2.3 %

Average deposits (in millions)

  $ 3,110     $ 2,888     $ 2,518     $ 592     23.5 %   $ 2,999     $ 2,411     $ 588     24.4 %

# employees - full-time equivalent (eop)

    574       567       590       (16 )   -2.7 %     574       590       (16 )   -2.7 %

# customers (eop)

    5,684       5,527       7,278       (1,594 )   -21.9 %     5,684       7,278       (1,594 )   -21.9 %

Mortgage Banking

                                                                   

Average loans (in millions)

  $ 2,032     $ 1,739     $ 1,173     $ 859     73.2 %   $ 1,886     $ 1,162     $ 724     62.3 %

Average deposits (in millions)

  $ 220     $ 149     $ 228     $ (8 )   -3.5 %   $ 185     $ 197     $ (12 )   -6.1 %

# employees - full-time equivalent (eop)

    609       604       614       (5 )   -0.8 %     609       614       (5 )   -0.8 %

Closed loan volume (in millions)

  $ 1,330     $ 860     $ 1,702     $ (372 )   -21.9 %   $ 2,190     $ 2,969     $ (779 )   -26.2 %

Portfolio closed loan volume (in millions)

  $ 863     $ 533     $ 362     $ 501     NM     $ 1,396     $ 731     $ 665     91.0 %

Agency delivery volume (in millions)

  $ 502     $ 342     $ 1,128     $ (626 )   -55.5 %   $ 844     $ 2,038     $ (1,194 )   -58.6 %

Total servicing portfolio (eop and in millions)

  $ 9,786     $ 9,442     $ 7,463     $ 2,323     31.1 %   $ 9,786     $ 7,463     $ 2,323     31.1 %

Portfolio serviced for others (eop and in millions)

  $ 6,537     $ 6,523     $ 5,069     $ 1,468     29.0 %   $ 6,537     $ 5,069     $ 1,468     29.0 %

Mortage servicing rights (eop and in millions)

  $ 79.2     $ 60.4     $ 36.7     $ 42.5     NM     $ 79.2     $ 36.7     $ 42.5     NM  

(1) Operating basis, see page 50 for definition.
(3) Total cross-sell on new relationships at 90 days (out of 16 core products).
(4) Total cross-sell on new relationships at 90 days (out of 18 products).
NM, not a meaningful value.
N/A, not available.
eop, end of period.


Table of Contents

Dealer Sales

 

Dealer Sales serves over 3,500 automotive dealerships within Huntington’s primary banking markets, as well as in Arizona, Florida, Georgia, Pennsylvania, and Tennessee. The segment finances the purchase of automobiles by customers of the automotive dealerships, purchases automobiles from dealers and simultaneously leases the automobiles under long-term direct financing leases, finances dealership floor plan inventories, real estate, or working capital needs, and provides other banking services to the automotive dealerships and their owners.

 

The accounting for automobile leases significantly impacts the presentation of Dealer Sales’ financial results. All automobile leases originated prior to May 2002 are accounted for as operating leases, with leases originated since April 2002 accounted for as direct financing leases. For automobile leases originated prior to May 2002, the related financial results are reported as operating lease income and operating lease expense, components of non-interest income and non-interest expense, respectively, whereas the cost of funding these leases is included in interest expense. Credit losses associated with these leases are also reflected in operating lease expense. With no new operating leases being originated, this portfolio, and related operating lease income and operating lease expense, will decrease over time and eventually become immaterial. In contrast, all new leases since April 2002 are originated as direct financing leases, where the income and funding are included in net interest income. The net interest margin increased during the three and six-month periods ended June 30, 2003, as compared with the same periods in 2004 as the declining operating lease portfolio resulted in less assessed interest expense. Direct financing lease credit losses are charged against an allowance for credit losses with provision for credit losses recorded to maintain an appropriate allowance level.

 

Residual values on leased automobiles are evaluated periodically for impairment. Residual value losses arise if the market value at the end of the lease term is less than the residual value embedded in the original lease contract. Residual value insurance covers the difference between the recorded residual value and the fair value of the automobile at the end of the lease term. Impairment of the residual values of direct financing leases is recognized by writing the leases down to fair value with a charge to non-interest income. Impairment of residual values of operating leases is evaluated under Statement No. 144. Under that Statement, when the future cash flows from the operating lease, including the expected realizable fair value of the automobile or equipment at the end of the lease, is less than the book value of the lease, an immediate impairment write-down is recognized. Otherwise, reductions in the expected residual value result in additional depreciation of the leased asset over the remaining term of the lease. Upon disposition, a gain or loss is recorded for any difference between the net book value of the lease and the proceeds from the disposition of the asset, including any insurance proceeds.

 

Second Quarter 2004 versus Second Quarter 2003 Performance

 

Dealer Sales contributed $21.0 million of the company’s net operating earnings in the second quarter of 2004, up $3.6 million, or 20%, from the 2003 second quarter. This increase was primarily due to higher net income from loan and lease assets (net interest income plus operating lease income less operating lease expense) and a lower provision for credit losses resulting from a decrease in charge-offs. The ROA and ROE for the second quarter of 2004 were 1.27% and 20.5%, respectively, up from 0.99% and 16.1%, respectively, in the 2003 second quarter.

 

Net interest income was $37.8 million, up $16.0 million, or 74%, from $21.7 million in the year-ago quarter. This significant increase reflected a $0.5 billion, or 10%, increase in average total loans and leases, as well as a 104 basis point increase in the net interest margin to 2.77% from 1.73% a year ago. The increase in average total loans and leases, and the net interest margin was driven by rapid growth in direct financing leases as average automobile loans declined due to loan sales.

 

Average automobile direct financing leases increased $833 million, reflecting the fact that this is still a relatively young portfolio with relatively fewer maturities and pay-offs than a more mature portfolio. Direct financing lease originations totaled $246 million in the second quarter of 2004, down 37% from $389 million in the 2003 second quarter. The growth in average direct financing lease balances contrasts with the $825 million decline in average operating lease assets, which consists of all leases originated prior to May 2002 with balances running off through maturities and pay-offs.

 

Average automobile loans declined $491 million compared with the same period a year ago, reflecting sales of automobile loans. Automobile loan originations declined $213 million, or 33%, to $431 million in the 2004 second quarter compared with $644 million in the 2003 second quarter, reflecting a softer market for new and used vehicle sales, as well as a decision to maintain high quality originations. The impact of the loan sales and lower production levels was offset in part by the consolidation in July 2003 of $1.0 billion of previously securitized automobile loans related to the adoption of FIN 46.

 

Also contributing to the growth in average total loans and leases was a 20% increase in C&I loans, including dealer floor plan loans.

 

The net interest margin continued to be favorably impacted by the run-off of operating lease assets and the fact that all of the funding cost associated with these assets is reflected in interest expense, whereas the income is reflected in non-interest income. In contrast, the net interest margin was negatively impacted by growth in lower yielding direct financing lease balances, loan sales, and a lower net interest margin associated with securitized loans that are now recorded on balance sheet as a result of the adoption of FIN 46.

 

56


Table of Contents

The provision for credit losses decreased to $8.3 million from $9.2 million for the year-ago quarter, primarily reflecting a $1.3 million, or 14%, decline in charge-offs. The annualized net charge-off ratio for automobile loans was 0.96% in the second quarter of 2004, down from 1.06% in the 2003 second quarter, while the charge-off ratio for direct financing leases was 0.41%, down from 0.44% in the year-ago quarter.

 

Non-interest income decreased $51.2 million, or 37%, driven by a $50.2 million, or 39%, decline in operating lease income as that portfolio continued to run-off. Other non-interest income decreased $0.9 million, or 9%, primarily due to declines in securitization income that resulted from the adoption of FIN 46 in the third quarter of 2003. Non-interest expense declined $39.7 million, or 32%, primarily reflecting a $40.7 million, or 39%, decline in operating lease expense. Other non-interest expense increased slightly as lower residual value insurance costs were offset by a loss accrual for expenses associated with pending litigation. In contrast, personnel costs increased $0.8 million, or 16%, primarily due to higher benefit costs and less benefit from deferring loan origination costs, reflecting the decline in loan and lease production.

 

Second Quarter 2004 versus First Quarter 2004 Performance

 

Dealer Sales’ net operating earnings of $21.0 million in the second quarter of 2004 were up $9.1 million, or 76%, from the first quarter of 2004. The primary contributor to this increase was a lower provision for credit losses. The ROA and ROE in the 2004 second quarter were 1.27% and 20.5%, respectively, up from 0.65% and 10.7%, respectively, in the 2004 first quarter.

 

Net interest income was $37.8 million for second quarter of 2004, up $2.8 million, or 8%, from the previous quarter. This increase reflected a 41 basis point increase in the net interest margin to 2.77% from 2.36%, partially offset by an 8% decline in average total loans and leases.

 

Average automobile loans decreased $704 million, or 23%, primarily as a result of the sale loans. Also contributing to the decline from the 2004 first quarter was a 12% decrease in automobile loan originations in the second quarter of 2004 compared with the first quarter.

 

Average automobile direct financing leases increased $151 million, or 8%, reflecting the fact that this continues to be a relatively young portfolio. However, direct financing lease originations declined 11% compared with the first quarter of 2004. The $151 million, or 8%, growth in average direct financing lease balances contrasts with the $189 million, or 16%, decline in average operating lease assets.

 

During the second quarter of 2004, C&I loans, including dealer floor plan loans, increased $52 million, or 7%, from the prior quarter, consistent with seasonal patterns for usage of available credit lines.

 

The provision for credit losses decreased 62%, reflecting both lower charge-offs and lower provision expense for growth in loans and direct financing leases. Charge-offs in the 2004 second quarter represented an annualized 0.58%, down from 1.14% in the first quarter. The first quarter of 2004 included a $4.7 million one-time charge to correct for the classification of claims received under policies purchased to protect the company from loss in the event repossessed vehicles had physical damage.

 

Non-interest income decreased $8.3 million, or 9%, primarily due to a $10.4 million, or 12%, decline in operating lease income as that portfolio continues to run-off. This decrease was partially offset by increases in servicing fee income, securitization income, and fee income from lease terminations. Non-interest expense declined $5.6 million, or 6%, primarily reflecting an $8.4 million, or 12%, decline in operating lease expense, offset in part by a loss accrual in other expense associated with pending litigation.

 

2004 First Six Months versus 2003 First Six Months

 

Dealer Sales contributed $33.0 million of the company’s net operating earnings for the first six months of 2004, down slightly from $33.5 million for the same period a year ago. Earnings in 2004 compared with 2003 were primarily impacted by a higher provision for credit losses, which was driven by increased charge-offs and the provision for credit losses associated with loan and lease growth, offset by higher net income from loan and lease assets. The ROA and ROE for the first six months of 2004 were 0.95% and 15.3%, respectively, compared with 0.94% and 15.3%, respectively, for the 2003 six-month period.

 

57


Table of Contents

Net interest income was $72.7 million, up $29.1 million, or 67%, from $43.6 million in the year-ago period. This significant increase reflected an $806 million, or 17%, increase in average total loans and leases, as well as a 79 basis point increase in the net interest margin to 2.55% from 1.76% a year ago. The significant increase in average total loans and leases, as well as the net interest margin, was driven by rapid growth in direct financing leases as average automobile loans declined.

 

Average automobile direct financing leases increased $911 million, or 79%, reflecting the fact that this is still a relatively young portfolio with fewer maturities and pay-offs than a more mature portfolio. Direct financing lease originations totaled $522 million in the first six months of 2004, down 25% from $699 million in the first six months of 2003. The growth in average direct financing lease balances contrasts with the $867 million, or 45%, decline in average operating lease assets, which consists of all leases originated prior to May 2002 with balances running off through maturities and pay-offs.

 

Average automobile loans declined $263 million compared with the same period a year ago, reflecting the impact of loan sales, as well as a $436 million, or 32%, decline in originations, reflecting a softer market for new and used vehicle sales, as well as a decision to maintain high quality loan originations. The impact of the loan sales and lower production levels was offset in part by the consolidation in July 2003 of $1.0 billion of previously securitized loans related to the adoption of FIN 46.

 

Also contributing to the growth in average total loans and leases was a $121 million, or 18%, increase in C&I loans, including dealer floor plan loans.

 

The net interest margin continued to be favorably impacted by the run-off of the operating lease assets and the fact that all of the funding cost associated with these assets is reflected in interest expense, whereas the income is reflected in non-interest income. In contrast, the net interest margin was negatively impacted by growth in lower yielding direct financing lease balances, loan sales, and a lower net interest margin associated with securitized loans that are now recorded on balance sheet as a result of the adoption of FIN 46.

 

The provision for credit losses increased from $20.6 million from the year-ago period to $29.9 million, reflecting growth in direct financing leases, an increase in provision allocation factors and a $3.6 million increase in charge-offs. Though net charge-offs increased $3.6 million from the year-ago six-month period, as an annualized percent of average total loans and leases, total net charge-offs were unchanged at 0.87%.

 

Non-interest income decreased $103.0 million, or 36%, driven by a $99.6 million, or 37%, decline in operating lease income as that portfolio continued to run-off. Other non-interest income decreased $2.5 million, or 14%, primarily due to declines in securitization income that resulted from the adoption of FIN 46 in the third quarter of 2003. Non-interest expense declined $82.5 million, or 32%, primarily reflecting an $81.6 million, or 38%, decline in operating lease expense. Other non-interest expense declined $2.4 million, or 7%, primarily due to lower residual value insurance costs. In contrast, personnel costs increased $1.4 million, or 14%, primarily due to higher benefit costs and less benefit from deferring loan origination costs, reflecting the decline in loan and lease production.

 

58


Table of Contents
    2004

  2004

  2003

  2Q04 vs. 2Q03

    2004

  2003

  1H04 vs. 1H03

 
    Second

  First

  Second

  Amount

    %

    6 Months

  6 Months

  Amount

    %

 

INCOME STATEMENT (in thousands)

                                                         

Net Interest Income

  $ 37,757   $ 34,951   $ 21,727   $ 16,030     73.8 %   $ 72,708   $ 43,642   $ 29,066     66.6 %

Provision for credit losses

    8,261     21,655     9,191     (930 )   -10.1 %     29,916     20,576     9,340     45.4 %
   

 

 

 


 

 

 

 


 

Net Interest Income After Provision for Credit Losses

    29,496     13,296     12,536     16,960     NM       42,792     23,066     19,726     85.5 %
   

 

 

 


 

 

 

 


 

Operating lease income

    78,379     88,818     128,574     (50,195 )   -39.0 %     167,197     266,767     (99,570 )   -37.3 %

Service charges on deposit accounts

    230     199     231     (1 )   -0.4 %     429     438     (9 )   -2.1 %

Brokerage and insurance income

    335     510     851     (516 )   -60.6 %     845     2,193     (1,348 )   -61.5 %

Trust services

    —       —       6     (6 )   -100.0 %     —       6     (6 )   -100.0 %

Mortgage banking

    —       —       —       —       NM       —       2     (2 )   -100.0 %

Other service charges and fees

    —       —       —       —       NM       —       —       —       NM  

Other

    9,218     6,926     10,145     (927 )   -9.1 %     16,144     18,662     (2,518 )   -13.5 %
   

 

 

 


 

 

 

 


 

Total Non-Interest Income Before Securities Gains

    88,162     96,453     139,807     (51,645 )   -36.9 %     184,615     288,068     (103,453 )   -35.9 %

Securities gains

    469     —       —       469     NM       469     —       469     NM  
   

 

 

 


 

 

 

 


 

Total Non-Interest Income

    88,631     96,453     139,807     (51,176 )   -36.6 %     185,084     288,068     (102,984 )   -35.7 %
   

 

 

 


 

 

 

 


 

Operating lease expense

    62,288     70,666     102,939     (40,651 )   -39.5 %     132,954     214,527     (81,573 )   -38.0 %

Personnel costs

    5,666     5,901     4,882     784     16.1 %     11,567     10,122     1,445     14.3 %

Other

    17,814     14,802     17,643     171     1.0 %     32,616     34,984     (2,368 )   -6.8 %
   

 

 

 


 

 

 

 


 

Total Non-Interest Expense

    85,768     91,369     125,464     (39,696 )   -31.6 %     177,137     259,633     (82,496 )   -31.8 %
   

 

 

 


 

 

 

 


 

Income Before Provision for Income Taxes

    32,359     18,380     26,879     5,480     20.4 %     50,739     51,501     (762 )   -1.5 %

Provision for income taxes (2)

    11,326     6,433     9,408     1,918     20.4 %     17,759     18,026     (267 )   -1.5 %
   

 

 

 


 

 

 

 


 

Net Income - Operating (1)

  $ 21,033   $ 11,947   $ 17,471   $ 3,562     20.4 %   $ 32,980   $ 33,475   $ (495 )   -1.5 %
   

 

 

 


 

 

 

 


 

Revenue - Fully Taxable Equivalent (FTE)

                                                         

Net Interest Income

  $ 37,757   $ 34,951   $ 21,727   $ 16,030     73.8 %   $ 72,708   $ 43,642   $ 29,066     66.6 %

Tax Equivalent Adjustment(2)

    —       —       —       —       NM       —       —       —       NM  
   

 

 

 


 

 

 

 


 

Net Interest Income (FTE)

    37,757     34,951     21,727     16,030     73.8 %     72,708     43,642     29,066     66.6 %

Non-Interest Income

    88,631     96,453     139,807     (51,176 )   -36.6 %     185,084     288,068     (102,984 )   -35.7 %
   

 

 

 


 

 

 

 


 

Total Revenue (FTE)

  $ 126,388   $ 131,404   $ 161,534   $ (35,146 )   -21.8 %   $ 257,792   $ 331,710   $ (73,918 )   -22.3 %
   

 

 

 


 

 

 

 


 

Total Revenue Excluding Securities Gains (FTE)

  $ 125,919   $ 131,404   $ 161,534   $ (35,615 )   -22.0 %   $ 257,323   $ 331,710   $ (74,387 )   -22.4 %
   

 

 

 


 

 

 

 


 

SELECTED AVERAGE BALANCES (in millions)

                                                         

Loans:

                                                         

C&I

  $ 808   $ 756   $ 673   $ 135     20.1 %   $ 782   $ 661   $ 121     18.3 %

CRE

                                                         

Construction

    3     8     6     (3 )   -50.0 %     6     4     2     50.0 %

Commercial

    80     81     64     16     25.0 %     81     62     19     30.6 %

Consumer

                                                         

Auto leases – indirect

    2,139     1,988     1,306     833     63.8 %     2,064     1,153     911     79.0 %

Auto loans – indirect

    2,332     3,036     2,823     (491 )   -17.4 %     2,684     2,947     (263 )   -8.9 %

Home equity loans & lines of credit

    0     0     0     0     NM       0     0     0     NM  

Other loans

    74     70     57     17     29.8 %     72     56     16     28.6 %
   

 

 

 


 

 

 

 


 

Total Consumer

    4,545     5,094     4,186     359     8.6 %     4,820     4,156     664     16.0 %
   

 

 

 


 

 

 

 


 

Total Loans

  $ 5,436   $ 5,939   $ 4,929   $ 507     10.3 %   $ 5,689   $ 4,883   $ 806     16.5 %
   

 

 

 


 

 

 

 


 

Operating lease assets

  $ 977   $ 1,166   $ 1,802   $ (825 )   -45.8 %   $ 1,070   $ 1,937   $ (867 )   -44.8 %

Deposits:

                                                         

Non-interest bearing deposits

  $ 67   $ 65   $ 55   $ 12     21.8 %   $ 66   $ 55   $ 11     20.0 %

Interest bearing demand deposits

    2     2     1     1     100.0 %     2     1     1     100.0 %

Foreign time deposits

    4     4     4     0     0.0 %     4     4     0     0.0 %
   

 

 

 


 

 

 

 


 

Total Deposits

  $ 73   $ 71   $ 60   $ 13     21.7 %   $ 72   $ 60   $ 12     20.0 %
   

 

 

 


 

 

 

 


 


(1) Operating basis, see page 50 for definition.
(2) Calculated assuming a 35% tax rate.

NM, not a meaningful value.

 

59


Table of Contents

Table 19 - Dealer Sales(1)

 

    2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

    1H04 vs. 1H03

 
    Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

    Amount

    %

 

PERFORMANCE METRICS

                                                                   

Return on average assets

    1.27 %     0.65 %     0.99 %     0.28 %           0.95 %     0.94 %     0.00 %      

Return on average equity

    20.5 %     10.7 %     16.1 %     4.4 %           15.3 %     15.3 %     0.1 %      

Net interest margin

    2.77 %     2.36 %     1.73 %     1.04 %           2.55 %     1.76 %     0.79 %      

Efficiency ratio

    68.1 %     69.5 %     77.7 %     -9.6 %           68.8 %     78.3 %     -9.4 %      

CREDIT QUALITY

                                                                   

Net Charge-offs by Loan Type (in thousands)

                                                                   

C&I

  $ 36     $ 1     $ —       $ 36     NM     $ 37     $ (38 )   $ 75     NM  

CRE

    —         —         —         —       NM       —         —         —       NM  
   


 


 


 


 

 


 


 


 

Total commercial

    36       1       —         36     NM       37       (38 )     75     NM  

Consumer

                                                                   

Auto leases

    2,159       3,159       1,422       737     51.8 %     5,318       2,342       2,976     NM  

Auto loans

    5,564       13,443       7,490       (1,926 )   -25.7 %     19,007       18,124       883     4.9 %

Home equity loans & lines of credit

    —         —         —         —       NM       —         —         —       NM  

Other loans

    38       211       177       (139 )   -78.5 %     249       575       (326 )   -56.7 %
   


 


 


 


 

 


 


 


 

Total consumer

    7,761       16,813       9,089       (1,328 )   -14.6 %     24,574       21,041       3,533     16.8 %
   


 


 


 


 

 


 


 


 

Total Net Charge-offs

  $ 7,797     $ 16,814     $ 9,089     $ (1,292 )   -14.2 %   $ 24,611     $ 21,003     $ 3,608     17.2 %
   


 


 


 


 

 


 


 


 

Net Charge-offs—annualized percentages

                                                                   

C&I

    0.02 %     0.00 %     0.00 %     0.02 %           0.01 %     -0.01 %     0.02 %      

CRE

    0.00 %     0.00 %     0.00 %     0.00 %           0.00 %     0.00 %     0.00 %      

Total commercial

    0.02 %     0.00 %     0.00 %     0.02 %           0.01 %     -0.01 %     0.02 %      

Consumer

                                                                   

Auto leases

    0.41 %     0.64 %     0.44 %     -0.03 %           0.52 %     0.41 %     0.11 %      

Auto loans

    0.96 %     1.78 %     1.06 %     -0.10 %           1.42 %     1.24 %     0.18 %      

Home equity loans & lines of credit

    NM       NM       NM       NM             NM       NM       NM        

Other loans

    0.21 %     1.21 %     1.25 %     -1.04 %           0.69 %     2.07 %     -1.38 %      
   


 


 


 


 

 


 


 


 

Total consumer

    0.69 %     1.33 %     0.87 %     -0.18 %           1.02 %     1.02 %     0.00 %      
   


 


 


 


 

 


 


 


 

Total Net Charge-offs

    0.58 %     1.14 %     0.74 %     -0.16 %           0.87 %     0.87 %     0.00 %      
   


 


 


 


 

 


 


 


 

Non-performing Assets (NPA) (in millions)

                                                                   

C&I

  $ —       $ —       $ —       $ —       NM     $ —       $ —       $ —       NM  

CRE

    —         —         —         —       NM       —         —         —       NM  
   


 


 


 


 

 


 


 


 

Total Non-accrual Loans

    0       0       0       0     NM       0       0       0     NM  

Renegotiated loans

    —         —         —         —       NM       —         —         —       NM  
   


 


 


 


 

 


 


 


 

Total Non-performing Loans (NPL)

    0       0       0       —       NM       0       0       —       NM  

Other real estate, net (OREO)

    —         —         —         —       NM       —         —         —       NM  
   


 


 


 


 

 


 


 


 

Total Non-performing Assets

  $ —       $ —       $ —       $ —       NM     $ —       $ —       $ —       NM  
   


 


 


 


 

 


 


 


 

Accruing loans past due 90 days or more

  $ 8     $ 9     $ 11     $ (3 )   -27.3 %   $ 8     $ 11     $ (3 )   -27.3 %

Allowance for Loan and Lease Losses (ALLL) (eop)

  $ 50     $ 51     $ 63     $ (13 )   -20.6 %   $ 50     $ 63     $ (13 )   -20.6 %

ALLL as a % of total loans and leases

    1.01 %     0.96 %     1.36 %     -0.35 %           1.01 %     1.36 %     -0.35 %      

ALLL as a % of NPLs

    NM       NM       NM       NM             NM       NM       NM        

ALLL + OREO as a % of NPAs

    NM       NM       NM       NM             NM       NM       NM        

NPLs as a % of total loans and leases

    0.00 %     0.00 %     0.00 %     0.00 %           0.00 %     0.00 %     0.00 %      

NPAs as a % of total loans and leases + OREO

    0.00 %     0.00 %     0.00 %     0.00 %           0.00 %     0.00 %     0.00 %      

(1) Operating basis, see page 50 for definition.
NM, not a meaningful value.
eop, end of period.

 

60


Table of Contents

Table 19 - Dealer Sales(1)

 

     2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

    1H04 vs. 1H03

 
     Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

    Amount

    %

 

SUPPLEMENTAL DATA

                                                                

# employees - full-time equivalent (eop)

     409       433       441     (32 )   -7.3 %     409       441     (32 )   -7.3 %

Automobile loans

                                                                

Production (in millions)

   $ 431.2     $ 487.9     $ 644.2     (213 )   -33.1 %   $ 919.1     $ 1,355.5     (436 )   -32.2 %

% Production new vehicles

     52.0 %     52.7 %     55.1 %   -3.1 %           52.4 %     53.6 %   -1.2 %      

Average term (in months)

     65.1       64.7       64.3     0.8             64.9       64.2     0.7        

Automobile leases

                                                                

Production (in millions)

   $ 246.4     $ 275.4     $ 388.7     (142 )   -36.6 %   $ 521.8     $ 698.9     (177 )   -25.3 %

% Production new vehicles

     99.1 %     98.9 %     96.9 %   2.2 %           99.0 %     95.7 %   3.3 %      

Average term (in months)

     54.6       53.4       52.4     2.2             54.0       53.0     0.9        

Average residual %

     41.0 %     42.3 %     43.7 %   -2.7 %           41.7 %     42.9 %   -1.2 %      

(1) Operating basis, see page 50 for definition.

eop, end of period.

 

61


Table of Contents

Private Financial Group

 

The Private Financial Group (PFG) provides products and services designed to meet the needs of the company’s higher net worth customers. Revenue is derived through trust, asset management, investment advisory, brokerage, insurance, and private banking products and services. The trust division provides fiduciary services to more than 11,000 accounts with assets totaling $39.2 billion, including $8.7 billion managed by PFG. In addition, PFG has over $560 million in assets managed by Haberer Registered Investment Advisor, which provides investment management services to nearly 400 customers.

 

PFG provides investment management and custodial services to the company’s 29 proprietary mutual funds, including ten variable annuity funds, which represented nearly $3 billion in total assets under management at June 30, 2004. The Huntington Investment Company offers brokerage and investment advisory services to both Regional Banking and PFG customers through more than 100 licensed investment sales representatives and 700 licensed personal bankers. This customer base has over $4 billion in mutual fund and annuity assets. PFG’s insurance entities provide a complete array of insurance products including individual life insurance products ranging from basic term life insurance, to estate planning, group life and health insurance, property and casualty insurance, mortgage title insurance, and reinsurance for payment protection products. Income and related expenses from the sale of brokerage and insurance products is shared with the line of business that generated the sale or provided the customer referral, most notably Regional Banking.

 

2004 Second Quarter versus 2003 Second Quarter

 

The Private Financial Group (PFG) contributed $6.3 million of the company’s net operating earnings in the second quarter of 2004, down $1.7 million, or 21%, from the second quarter of 2003. The decline primarily reflected higher non-interest expense and provision for credit losses, partially offset by an increase in net interest income. The ROA in the 2004 second quarter was 1.67%, down from 2.45% in the year-ago quarter. The ROE was 21.3% in the current quarter, down from 30.3% in the 2003 second quarter.

 

Net interest income increased $1.4 million, or 14%, from the year-ago quarter as average loan balances increased $200 million, or 17%, and average deposit balances increased $87 million, or 9%. Most of the loan growth occurred in residential real estate loans and home equity loans and lines, largely due to the favorable mortgage rate environment. Total C&I and CRE loans grew 8% from the prior-year quarter. Loan growth reflected initiatives to add relationship managers in several markets targeted for growth opportunities, most notably East and West Michigan and Central and Southern Ohio. Most of the deposit growth was attributable to growth in commercial non-interest bearing and interest bearing demand deposit accounts aided by favorable rate offerings. The net interest margin declined 9 basis points from the year-ago quarter to 3.14%, reflecting growth in lower-margin loans partially offset by deposit growth.

 

Provision for credit losses increased $1.1 million from the year-ago quarter. The increase was mainly due to the fact that the year-ago quarter included a provision credit resulting from a large, previously non-performing loan being brought current, thus freeing-up reserves. The annualized total net charge-off ratio increased to 0.27% in the second quarter 2004 from 0.15% in the year-ago quarter, primarily reflecting timing differences as evidenced by the fact that the annualized net charge-offs ratio for the first six months of 2004 was unchanged from the comparable year-ago period.

 

Non-interest income, net of fees shared with other business units, was down $0.2 million from the year-ago quarter, reflecting declines in brokerage and insurance revenue, other income, and mortgage banking income, only partially offset by growth in trust income. Brokerage and insurance revenue decreased $0.8 million, or 9%. This reflected a $0.7 million, or 20%, decline in insurance revenue mainly due to a decrease in title insurance revenue reflecting the slowdown in mortgage refinancing activity, as well as a $0.2 million, or 3%, decline in annuity revenues. The annuity revenue decrease of 3% was less than the 6% decline in annuity sales, reflecting a shift from lower-margin fixed annuity sales in the year-ago quarter to higher-margin variable and indexed annuity sales in the current quarter. While mutual fund sales volume declined 24%, mutual fund revenue increased 23%, as sales in the year-ago quarter consisted of more low-margin, individual trades greater than $1 million each. Trust income increased $1.2 million, or 8%, mainly due to revenue growth in personal trust and investment management business. Total trust assets grew 15% to $39.2 billion at June 30, 2004, from $34.2 billion at June 30, 2003. For the same periods, managed assets grew 6% to $9.3 billion from $8.8 billion. Asset growth resulted from a combination of market value growth and strong new business development, which continued to reflect the success of the new business delivery model utilizing the brokerage sales force to sell asset management services.

 

62


Table of Contents

Non-interest expense increased $2.7 million, or 10%, from the 2003 second quarter primarily due to a 14% increase in personnel costs. This increase reflected growth in the brokerage sales force to support the new sales distribution model, an increase in private banking relationship managers to support the expansion of the private banking presence in selected markets, higher trust and investment management sales commissions from increased new business development, and higher benefit costs.

 

2004 Second Quarter versus 2004 First Quarter

 

PFG’s $6.3 million net contribution to the company’s operating earnings in the second quarter of 2004 was down $0.8 million, or 11%, from the 2004 first quarter. The decrease was primarily due to higher provision for credit losses, lower non-interest income driven by a decline in broker and insurance revenue, only partially offset by lower non-interest expense. The ROA in the second quarter was 1.67%, down slightly from 1.92% in the first quarter. The ROE was 21.3% in the current quarter, down from 24.2% in the previous quarter.

 

Net interest income was essentially unchanged from the previous quarter. Average loan balances increased by $34 million, or 3%, while average deposit balances decreased by $23 million, or 2%. Average loan growth in the current quarter was primarily in C&I and CRE loans. The decline in deposit balances partially reflected normal historical trends resulting from annual income tax payments, but also some balance run-off due to higher competitive rates, most notably in East Michigan. The decline in deposits, combined with the increase in lower-margin consumer loans, was reflected in a 10 basis point decline in the net interest margin to 3.14% from 3.24% in the first quarter.

 

Provision for credit losses increased $1.2 million from the prior quarter. The increase was largely due to a provision credit in the first quarter 2004 resulting from a large, fully-reserved loan being brought current. Although the annualized total net charge-off ratio increased to 0.27% in the current quarter from 0.06% in the first quarter, this had little impact on provision expense in the current period as several of the larger second quarter charge-offs had been fully reserved.

 

Non-interest income, net of fees shared with other business units, decreased $0.9 million, or 3%, from the first quarter, primarily reflecting a $2.1 million, or 20%, decline in brokerage and insurance income. Annuity revenue decreased $1.5 million as sales volume decreased 17%. The decline in annuity sales was attributable to several factors, including a slowdown in customer demand given future interest rate movement uncertainty, increased focus on growing deposits including increased rates offered on CDs, and normal post income-tax season sales decline. Mutual fund revenue declined 16% as sales in the current quarter consisted of more low-margin, individual trades greater than $1 million each. Insurance income decreased $0.2 million from the prior quarter primarily due to reduced sales in the life insurance agency business.

 

Trust income increased $0.5 million, or 3%, from the previous quarter. While total trust and managed assets both grew only slightly, the increase in related income was driven by growth in total personal trust assets and managed personal trust assets, both of which grew by more than 4% during the quarter. Personal trust asset growth continued despite flat market trends, which illustrated strong new business development due in part to the success of the new business delivery model, which utilizes the brokerage sales force to sell asset management services. Other income increased $0.4 million from the first quarter due to increased income from annual BOLI insurance premiums and securities gains.

 

Non-interest expense decreased $0.9 million, or 3%, from the prior quarter, primarily reflecting lower personnel costs due to a decline in commission expense as a result of the reduction in brokerage and insurance revenue.

 

2004 First Six Months versus 2003 First Six Months

 

PFG’s $13.3 million net contribution to the company’s operating earnings for the first six months of 2004 was essentially unchanged from the first six months of 2003 as the benefits of the growth in net interest income, lower provision for credit losses, as well as higher non-interest income, was offset by increased non-interest expense. The ROA for 2004 year-to-date was 1.79%, down from 2.10% for the same period in 2003. The ROE was 22.6% and 26.7% for the first six months of 2004 and 2003, respectively.

 

63


Table of Contents

Net interest income for the first six months of 2004 increased $3.0 million, or 16%, from the comparable 2003 period as a result of strong growth in average loans and deposits. Average loans increased $212 million, or 19%, while average deposit balances increased $125 million, or 13%. Much of the loan growth was in residential real estate loans and home equity loans and lines, largely due to historically low mortgage rates. Loan growth also reflected an initiative to add relationship managers in 2004 in several markets targeted for growth opportunities, most notably East and West Michigan and Central and Southern Ohio. The deposit growth occurred mainly in consumer and commercial interest bearing accounts, which increased $88 million, or 14%, aided by promotional rate offerings resulting in both new accounts and a redirection of sweep account balances from money market mutual fund accounts. Non-interest bearing deposits also contributed to the growth in deposits, increasing $30 million, or 21%, from the comparable year-ago period. The growth in lower-margin consumer loans contributed to the 9 basis point decline in the net interest margin to 3.18% for the first half 2004 from 3.27% in the year-ago period.

 

Provision for credit losses decreased $1.3 million in the current six-month period from the prior-year period. This was due to a methodology change in 2003, which increased provision expense for unfunded commitments and unsecured credits. The annualized total net charge-off ratio for the first six months of 2004 was 0.17%, unchanged from the first half of 2003.

 

Non-interest income, net of fees shared with other business units, increased $1.2 million, or 2%, from the first six months of 2003 mainly as a result of increased trust income. Trust income increased $2.6 million, or 9%, primarily due to revenue growth in the personal trust and investment management business. Total trust assets grew 15% to $39.2 billion at June 30, 2004, from $34.2 billion at June 30, 2003. For the same period, managed assets grew 6% from $8.8 billion to $9.3 billion. Asset growth resulted from a combination of market value growth and strong new business development, which continued to reflect the success of the new business delivery model utilizing the brokerage sales force to sell asset management services.

 

Brokerage and insurance revenue was essentially unchanged from the prior-year six-month period as increased mutual fund revenue was offset by a decrease in insurance fees and annuity income. Mutual fund revenue increased $1.0 million, or 52%, despite a 21% decline in mutual fund sales volumes as sales in the first half of 2003 consisted of more low-margin, individual trades greater than $1 million each. Annuity revenue decreased $0.3 million due to a decline in sales volume. Annuity sales were extremely strong in early 2003 as promotional rates helped capture a significant amount of maturing CD business. Insurance income decreased $1.7 million, or 23%, primarily due to a change in accounting methodology in 2004 related to insurance coverage provided on automobile loans and leases, whereby agency commissions and excess premium refunds are no longer recognized as insurance revenue.

 

Mortgage banking income decreased by $0.6 million due to increased mortgage portfolio servicing costs resulting from the growth in residential real estate mortgage loans and due to a change in fee sharing methodology that resulted in reduced income shared by Huntington Mortgage Group. Other income decreased by $0.8 million as a result of a decline in fee sharing revenue received from Huntington Capital Corporation based on fewer interest rate swap referrals, and investment portfolio gains realized in the year-ago period.

 

Non-interest expense increased $5.5 million, or 10%, in the first half 2004 from the first half 2003, primarily due to 13% increase in personnel costs. This increase reflected the same factors which impacted 2004 second quarter versus 2003 second quarter performance. In addition, other expense increased $1.4 million, or 6%, reflecting a $1.1 million increase in allocated expense for corporate overhead and other indirect and product-related expenses.

 

64


Table of Contents

Table 20 - Private Financial Group(1)

 

    2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

  1H04 vs. 1H03

 
    Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

  Amount

    %

 

INCOME STATEMENT (in thousands)

                                                                 

Net Interest Income

  $ 11,166     $ 11,129     $ 9,785     $ 1,381     14.1 %   $ 22,295     $ 19,280   $ 3,015     15.6 %

Provision for credit losses

    654       (557 )     (457 )     1,111     NM       97       1,443     (1,346 )   -93.3 %
   


 


 


 


 

 


 

 


 

Net Interest Income After Provision for Credit Losses

    10,512       11,686       10,242       270     2.6 %     22,198       17,837     4,361     24.4 %
   


 


 


 


 

 


 

 


 

Service charges on deposit accounts

    1,002       925       966       36     3.7 %     1,927       1,952     (25 )   -1.3 %

Brokerage and insurance income

    8,488       10,616       9,287       (799 )   -8.6 %     19,104       19,218     (114 )   -0.6 %

Trust services

    16,483       16,031       15,294       1,189     7.8 %     32,514       29,937     2,577     8.6 %

Mortgage banking

    (104 )     (129 )     188       (292 )   NM       (233 )     367     (600 )   NM  

Other service charges and fees

    116       100       113       3     2.7 %     216       211     5     2.4 %

Other

    1,445       1,084       2,036       (591 )   -29.0 %     2,529       3,369     (840 )   -24.9 %
   


 


 


 


 

 


 

 


 

Total Non-Interest Income Before Securities Gains

    27,430       28,627       27,884       (454 )   -1.6 %     56,057       55,054     1,003     1.8 %

Securities gains

    250       —         (34 )     284     NM       250       9     241     NM  
   


 


 


 


 

 


 

 


 

Total Non-Interest Income

    27,680       28,627       27,850       (170 )   -0.6 %     56,307       55,063     1,244     2.3 %
   


 


 


 


 

 


 

 


 

Personnel costs

    17,047       17,800       14,948       2,099     14.0 %     34,847       30,718     4,129     13.4 %

Other

    11,512       11,661       10,938       574     5.2 %     23,173       21,803     1,370     6.3 %
   


 


 


 


 

 


 

 


 

Total Non-Interest Expense

    28,559       29,461       25,886       2,673     10.3 %     58,020       52,521     5,499     10.5 %
   


 


 


 


 

 


 

 


 

Income Before Provision for Income Taxes

    9,633       10,852       12,206       (2,573 )   -21.1 %     20,485       20,379     106     0.5 %

Provision for income taxes (2)

    3,372       3,798       4,272       (900 )   -21.1 %     7,170       7,133     37     0.5 %
   


 


 


 


 

 


 

 


 

Net Income - Operating (1)

  $ 6,261     $ 7,054     $ 7,934     $ (1,673 )   -21.1 %   $ 13,315     $ 13,246   $ 69     0.5 %
   


 


 


 


 

 


 

 


 

Revenue - Fully Taxable Equivalent (FTE)

                                                                 

Net Interest Income

  $ 11,166     $ 11,129     $ 9,785     $ 1,381     14.1 %   $ 22,295     $ 19,280   $ 3,015     15.6 %

Tax Equivalent Adjustment (2)

    9       9       10       (1 )   -10.0 %     18       25     (7 )   -28.0 %
   


 


 


 


 

 


 

 


 

Net Interest Income (FTE)

    11,175       11,138       9,795       1,380     14.1 %     22,313       19,305     3,008     15.6 %

Non-Interest Income

    27,680       28,627       27,850       (170 )   -0.6 %     56,307       55,063     1,244     2.3 %
   


 


 


 


 

 


 

 


 

Total Revenue (FTE)

  $ 38,855     $ 39,765     $ 37,645     $ 1,210     3.2 %   $ 78,620     $ 74,368   $ 4,252     5.7 %
   


 


 


 


 

 


 

 


 

Total Revenue Excluding Securities Gains (FTE)

  $ 38,605     $ 39,765     $ 37,679     $ 926     2.5 %   $ 78,370     $ 74,359   $ 4,011     5.4 %
   


 


 


 


 

 


 

 


 

SELECTED AVERAGE BALANCES (in millions)

                                                                 

Loans:

                                                                 

C&I

  $ 339     $ 320     $ 311     $ 28     9.0 %   $ 330     $ 316   $ 14     4.4 %

CRE

                                                                 

Construction

    21       24       23       (2 )   -8.7 %     23       20     3     15.0 %

Commercial

    176       166       161       15     9.3 %     171       156     15     9.6 %

Consumer

                                                                 

Home equity loans & lines of credit

    294       287       250       44     17.6 %     291       245     46     18.8 %

Residential mortgage

    512       511       398       114     28.6 %     512       379     133     35.1 %

Other loans

    8       8       7       1     14.3 %     8       7     1     14.3 %
   


 


 


 


 

 


 

 


 

Total Consumer

    814       806       655       159     24.3 %     811       631     180     28.5 %
   


 


 


 


 

 


 

 


 

Total Loans

  $ 1,350     $ 1,316     $ 1,150     $ 200     17.4 %   $ 1,335     $ 1,123   $ 212     18.9 %
   


 


 


 


 

 


 

 


 

Deposits:

                                                                 

Non-interest bearing deposits

  $ 174     $ 169     $ 141     $ 33     23.4 %   $ 172     $ 142   $ 30     21.1 %

Interest bearing demand deposits

    712       753       667       45     6.7 %     733       645     88     13.6 %

Savings deposits

    49       46       55       (6 )   -10.9 %     48       51     (3 )   -5.9 %

Domestic time deposits

    106       96       95       11     11.6 %     101       98     3     3.1 %

Foreign time deposits

    21       21       17       4     23.5 %     21       14     7     50.0 %
   


 


 


 


 

 


 

 


 

Total Deposits

  $ 1,062     $ 1,085     $ 975     $ 87     8.9 %   $ 1,075     $ 950   $ 125     13.2 %
   


 


 


 


 

 


 

 


 


(1) Operating basis, see page 50 for definition.
(2) Calculated assuming a 35% tax rate.

NM, not a meaningful value.

 

65


Table of Contents

Table 20 - Private Financial Group(1)

 

     2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

    1H04 vs. 1H03

 
     Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

    Amount

    %

 

PERFORMANCE METRICS

                                                                    

Return on average assets

     1.67 %     1.92 %     2.45 %     -0.78 %           1.79 %     2.10 %     -0.32 %      

Return on average equity

     21.3 %     24.2 %     30.3 %     -9.0 %           22.6 %     26.7 %     -4.1 %      

Net interest margin

     3.14 %     3.24 %     3.23 %     -0.09 %           3.18 %     3.27 %     -0.09 %      

Efficiency ratio

     74.0 %     74.1 %     68.7 %     5.3 %           74.0 %     70.6 %     3.4 %      

CREDIT QUALITY

                                                                    

Net Charge-offs by Loan Type (in thousands)

                                                                    

C&I

   $ 840     $ 16     $ 333     $ 507     NM     $ 856     $ 635     $ 221     34.8 %

CRE

     —         —         2       (2 )   -100.0 %     —         2       (2 )   -100.0 %
    


 


 


 


 

 


 


 


 

Total commercial

     840       16       335       505     NM       856       637       219     34.4 %

Consumer

                                                                    

Home equity loans & lines of credit

     —         160       62       (62 )   -100.0 %     160       261       (101 )   -38.7 %

Residential mortgage

     —         —         —         —       NM       —         21       (21 )   -100.0 %

Other loans

     60       32       23       37     NM       92       34       58     NM  
    


 


 


 


 

 


 


 


 

Total consumer

     60       192       85       (25 )   -29.4 %     252       316       (64 )   -20.3 %
    


 


 


 


 

 


 


 


 

Total Net Charge-offs

   $ 900     $ 208     $ 420     $ 480     NM     $ 1,108     $ 953     $ 155     16.3 %
    


 


 


 


 

 


 


 


 

Net Charge-offs - annualized percentages

                                                                    

C&I

     1.00 %     0.02 %     0.43 %     0.57 %           0.52 %     0.41 %     0.11 %      

CRE

     0.00 %     0.00 %     0.00 %     0.00 %           0.00 %     0.00 %     0.00 %      
    


 


 


 


 

 


 


 


 

Total commercial and commercial real estate

     0.63 %     0.01 %     0.27 %     0.36 %           0.33 %     0.26 %     0.07 %      

Consumer

                             0.00 %                           0.00 %      

Home equity loans & lines of credit

     0.00 %     0.22 %     0.10 %     -0.10 %           0.11 %     0.21 %     -0.10 %      

Residential mortgage

     0.00 %     0.00 %     0.00 %     0.00 %           0.00 %     0.01 %     -0.01 %      

Other loans

     3.02 %     1.61 %     1.32 %     1.70 %           2.31 %     0.98 %     1.33 %      
    


 


 


 


 

 


 


 


 

Total consumer

     0.03 %     0.10 %     0.05 %     -0.02 %           0.06 %     0.10 %     -0.04 %      
    


 


 


 


 

 


 


 


 

Total Net Charge-offs

     0.27 %     0.06 %     0.15 %     0.12 %           0.17 %     0.17 %     0.00 %      
    


 


 


 


 

 


 


 


 

Non-performing Assets (NPA) (in millions)

                                                                    

C&I

   $ 2     $ 2     $ 1     $ 1     100.0 %   $ 2     $ 1     $ 1     100.0 %

CRE

     1       —         —         1     NM       1       —         1     NM  

Residential mortgage

     3       1       1       2     NM       3       1       2     NM  
    


 


 


 


 

 


 


 


 

Total Non-accrual Loans

     6       3       2       4     NM       6       2       4     NM  

Renegotiated loans

     —         —         —         —       NM       —         —         —       NM  
    


 


 


 


 

 


 


 


 

Total Non-performing Loans (NPL)

     6       3       2       4     NM       6       2       4     NM  

Other real estate, net (OREO)

     —         —         —         —       NM       —         —         —       NM  
    


 


 


 


 

 


 


 


 

Total Non-performing Assets

   $ 6     $ 3     $ 2     $ 4     NM     $ 6     $ 2     $ 4     NM  
    


 


 


 


 

 


 


 


 

Accruing loans past due 90 days or more

   $ 2     $ 4     $ 4     $ (2 )   -50.0 %   $ 2     $ 4     $ (2 )   -50.0 %

Allowance for Loan and Lease Losses (ALLL)(eop)

   $ 9     $ 9     $ 7     $ 2     28.6 %   $ 9     $ 7     $ 2     28.6 %

ALLL as a % of total loans and leases

     0.65 %     0.68 %     0.59 %     0.06 %           0.65 %     0.59 %     0.06 %      

ALLL as a % of NPLs

     150.0 %     300.0 %     350.0 %     -200.0 %           150.0 %     350.0 %     -200.0 %      

ALLL + OREO as a % of NPAs

     150.0 %     300.0 %     350.0 %     -200.0 %           150.0 %     350.0 %     -200.0 %      

NPLs as a % of total loans and leases

     0.43 %     0.23 %     0.17 %     0.26 %           0.43 %     0.17 %     0.26 %      

NPAs as a % of total loans and leases + OREO

     0.43 %     0.23 %     0.17 %     0.26 %           0.43 %     0.17 %     0.26 %      

(1) Operating basis, see page 50 for definition.
NM, not a meaningful value.
eop, end of period.

 

66


Table of Contents
    2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

    1H04 vs. 1H03

 
    Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

    Amount

    %

 

SUPPLEMENTAL DATA

                                                                   

# employees - full-time equivalent (eop)

    708       703       695       13     1.9 %     708       695       13     1.9 %

# licensed bankers (eop)

    698       701       685       13     1.9 %     698       685       13     1.9 %

Brokerage and Insurance Income (in thousands)

                                                                   

Mutual fund revenue

  $ 1,355     $ 1,610     $ 1,104     $ 251     22.7 %   $ 2,965     $ 1,954     $ 1,011     51.7 %

Annuities revenue

    6,776       8,229       6,982       (206 )   -3.0 %     15,005       15,307       (302 )   -2.0 %

12b-1 fees

    600       535       525       75     14.3 %     1,135       1,080       55     5.1 %

Discount brokerage commissions and other

    1,280       1,290       1,187       93     7.8 %     2,570       2,052       518     25.2 %
   


 


 


 


 

 


 


 


 

Total retail investment sales

    10,011       11,664       9,798       213     2.2 %     21,675       20,393       1,282     6.3 %

Investment banking fees

    —         —         —         —       NM       —         —         —       NM  

Insurance fees and revenue

    2,782       2,936       3,459       (677 )   -19.6 %     5,718       7,426       (1,708 )   -23.0 %
   


 


 


 


 

 


 


 


 

Total Brokerage and Insurance Income

  $ 12,793     $ 14,600     $ 13,257     $ (464 )   -3.5 %   $ 27,393     $ 27,819     $ (426 )   -1.5 %
   


 


 


 


 

 


 


 


 

Fee sharing

    4,305       3,984       3,970       335     8.4 %     8,289       8,601       (312 )   -3.6 %
   


 


 


 


 

 


 


 


 

Total Brokerage and Insurance Income (net of fee sharing)

  $ 8,488     $ 10,616     $ 9,287     $ (799 )   -8.6 %   $ 19,104     $ 19,218     $ (114 )   -0.6 %
   


 


 


 


 

 


 


 


 

Mutual fund sales volume, excluding direct trades (in thousands)

  $ 58,002     $ 42,965     $ 75,995       (17,993 )   -23.7 %   $ 100,967     $ 128,263       (27,296 )   -21.3 %

Annuities sales volume (in thousands)

    133,408       161,332       142,344       (8,936 )   -6.3 %     294,740       316,218       (21,478 )   -6.8 %

Trust Services Income (in thousands)

                                                                   

Personal trust revenue

  $ 8,423     $ 8,191     $ 7,502     $ 921     12.3 %   $ 16,614     $ 14,931     $ 1,683     11.3 %

Huntington funds revenue

    5,195       5,230       4,805       390     8.1 %     10,425       9,480       945     10.0 %

Institutional trust revenue

    2,176       2,170       2,218       (42 )   -1.9 %     4,346       3,943       403     10.2 %

Corporate trust revenue

    900       708       1,031       (131 )   -12.7 %     1,608       2,077       (469 )   -22.6 %

Other trust revenue

    —         —         —         —       NM       —         —         —       NM  
   


 


 


 


 

 


 


 


 

Total Trust Services Income

  $ 16,694     $ 16,299     $ 15,556     $ 1,138     7.3 %   $ 32,993     $ 30,431     $ 2,562     8.4 %
   


 


 


 


 

 


 


 


 

Fee sharing

    211       268       262       (51 )   -19.5 %     479       494       (15 )   -3.0 %
   


 


 


 


 

 


 


 


 

Total Trust Services Income (net of fee sharing)

  $ 16,483     $ 16,031     $ 15,294     $ 1,189     7.8 %   $ 32,514     $ 29,937     $ 2,577     8.6 %
   


 


 


 


 

 


 


 


 

Assets Under Management (eop) (in billions)

                                                                   

Personal trust

  $ 5.2     $ 5.0     $ 4.7     $ 0.4     9.4 %   $ 5.2     $ 4.7     $ 0.4     9.4 %

Huntington funds

    2.9       3.0       3.0       (0.1 )   -1.8 %     2.9       3.0       (0.1 )   -1.8 %

Institutional trust

    0.5       0.6       0.5       0.0     9.8 %     0.5       0.5       0.0     9.8 %

Corporate trust

    0.0       0.0       0.1       (0.1 )   -62.0 %     0.0       0.1       (0.1 )   -62.0 %

Haberer

    0.6       0.5       0.5       0.1     27.7 %     0.6       0.5       0.1     27.7 %

Other

    —         —         —         —       NM       —         —         —       NM  
   


 


 


 


 

 


 


 


 

Total Assets Under Management

  $ 9.3     $ 9.2     $ 8.8     $ 0.5     5.8 %   $ 9.3     $ 8.8     $ 0.5     5.8 %
   


 


 


 


 

 


 


 


 

Total Trust Assets (eop) (in billions)

                                                                   

Personal trust

  $ 8.9     $ 8.5     $ 7.7     $ 1.2     15.4 %   $ 8.9     $ 7.7     $ 1.2     15.4 %

Huntington funds

    2.9       3.0       3.0       (0.1 )   -3.0 %     2.9       3.0       (0.1 )   -3.0 %

Institutional trust

    23.9       24.6       20.3       3.6     17.7 %     23.9       20.3       3.6     17.7 %

Corporate trust

    3.5       3.1       3.2       0.3     8.4 %     3.5       3.2       0.3     8.4 %
   


 


 


 


 

 


 


 


 

Total Trust Assets

  $ 39.2     $ 39.1     $ 34.2     $ 5.0     14.5 %   $ 39.2     $ 34.2     $ 5.0     14.5 %
   


 


 


 


 

 


 


 


 

Mutual Fund Data

                                                                   

# Huntington mutual funds (eop)

    29       24       24       5             29       24       5        

Sales penetration (3)

    5.9 %     6.5 %     6.8 %     -0.9 %           6.2 %     7.0 %     -0.8 %      

Revenue penetration (whole dollars) (4)

  $ 3,270     $ 4,039     $ 3,298     $ (28 )   -0.8 %   $ 3,700     $ 3,436     $ 264     7.7 %

Profit penetration (whole dollars) (5)

    987       1,366       1,244       (257 )   -20.7 %     1,173       1,282       (109 )   -8.5 %

Average sales per licensed banker (whole dollars) annualized

    70,030       81,567       68,897       1,133     1.6 %     75,774       70,796       4,978     7.0 %

Average revenue per licensed banker (whole dollars) annualized

    3,319       3,967       3,049       270     8.9 %     3,639       3,203       436     13.6 %

(1) Operating basis, see page 50 for definition.
(3) Sales (dollars invested) of mutual funds and annuities divided by bank’s retail deposits.
(4) Investment program revenue per million of the bank’s retail deposits.
(5) Contribution of investment program to pretax profit per million of the bank’s retail deposits.

Contribution is difference between program revenue and program expenses.

NM, not a meaningful value.

eop, end of period.


Table of Contents

Treasury / Other

 

The Treasury/Other segment includes revenue and expense related to assets, liabilities, and equity that are not directly assigned or allocated to one of the other three business segments. Assets included in this segment include bank owned life insurance, investment securities, and mezzanine loans originated through Huntington Capital Markets.

 

Net interest income includes the net impact of administering Huntington’s investment securities portfolios as part of overall liquidity management. A match-funded transfer pricing system is used to attribute appropriate funding interest income and interest expense to other business segments. As such, net interest income includes the net impact of any over or under allocations arising from centralized management of interest rate risk. Furthermore, net interest income includes the net impact of derivatives used to hedge interest rate sensitivity as well as net interest income related to Huntington Capital Markets loan activity.

 

Non-interest income includes fee income related to Huntington Capital Markets activities, and miscellaneous non-interest income not allocated to other business segments, including bank owned life insurance income. Fee income also includes MSR temporary impairment valuation recoveries or impairments, as well as any securities gains or losses, which are used to mitigate MSR valuation changes. Prior to 2004, changes in MSR temporary impairment valuations were reflected in the Regional Banking business segment, whereas securities gains or loss were reflected in the Treasury/Other segment. Since securities gains or losses are used to mitigate MSR valuation changes, and since this risk is managed centrally, for 2004 reporting both MSR valuation changes, as well as securities gains or losses, are reflected in Treasury/Other results.

 

Non-interest expense includes expenses associated with Huntington Capital Markets activities, as well as certain corporate administrative and other miscellaneous expenses not allocated to other business segments.

 

The provision for income taxes for each of the other business segments is calculated at a statutory 35% tax rate though the company’s overall effective tax rate is lower. As a result, the provision for income taxes in Treasury/Other includes the difference between the actual effective tax rate and the statutory tax rate used to allocate income taxes to the other segments.

 

2004 Second Quarter versus 2003 Second Quarter

 

Treasury/Other net income declined $15.2 million, or 45% from the same quarter last year. This reflected a combination of higher non-interest expense, lower non-interest income, and lower net interest income, partially offset by lower provision for income taxes.

 

Net interest income decreased $2.0 million, or 10%, from the year-ago quarter. Driving this variance were a $5.3 million increase in wholesale funding costs and $7.5 million of lower revenue from derivatives activities, offset by $1.1 million of higher interest income in the Capital Markets margin and $10.0 million of higher interest income on securities.

 

The provision for credit losses was $0.1 million higher than last year, attributable to increased Huntington Capital Markets lending activity.

 

Non-interest income was $9.6 million, or 40%, lower than in the year-ago quarter, reflecting the impact of using securities losses to offset MSR impairment recoveries. In 2004, MSR impairment and recovery is reflected in the Treasury/Other segment, whereas in the year-ago quarter MSR impairment of $6.4 million was reflected in Regional Banking. Other non-interest income was also down from the year-ago quarter by $3.1 million, reflecting lower income from trading activities.

 

Non-interest expense for operational, administrative, and support groups, which was not specifically allocated to the other business segments was up $12.3 million from last year. Driving this variance was $5.5 million of higher incentive plan costs in the second quarter of 2004. Furthermore, $5.8 million of other expense attributable to costs related to investments in partnerships generating tax benefits occurred in the second quarter of 2004.

 

The provision for income taxes declined $8.8 million, reflecting lower pre-tax income, partially offset by a higher overall effective tax rate in the 2004 second quarter, compared with the year-ago quarter.

 

68


Table of Contents

2004 Second Quarter versus 2004 First Quarter

 

Treasury/Other’s net income was $12.5 million, or 40%, lower than the first quarter. This reflected a combination of lower non-interest income, lower net interest income, and higher non-interest expense, partially offset by lower provision for credit losses.

 

The net interest margin for Treasury/Other was down $7.0 million, or 27%. Driving this variance was lower net earnings from Huntington’s transfer pricing system to centrally manage interest rate risk. These earnings are allocated to the other lines of business units’.

 

Non-interest income was $7.1 million lower in the second quarter compared with the first quarter. Securities losses, offset by MSR impairment recovery, drive most of this reduction. Furthermore, investment banking activities from Huntington Capital Markets contributed $2.4 million less revenue in the second quarter, than in the first quarter.

 

Non-interest expense for Treasury/Other increased $2.2 million, or 13%, from the first quarter. Second quarter expenses include $5.8 million of other expense attributable to costs related to investments in partnerships generating tax benefits. Offsetting this variance is a higher net amount of expenses allocated to the other business segments.

 

The provision for credit losses decline $2.3 million, reflecting lower NPAs.

 

The provision for income taxes decreased $1.5 million, reflecting the benefit of the company’s lower overall effective tax rate versus the 35% effective tax rate used to allocate provision for income taxes to each line of business, partially offset by an increase in the company’s higher overall effective tax rate in the current quarter compared with the first quarter.

 

2004 First Six Months versus 2003 First Six Months

 

Treasury/Other net income for the first six months of 2004 declined $11.8 million, or 19%, from the comparable year-ago period. This reflected a combination of factors primarily consisting of higher non-interest expense, lower non-interest income, and an increase in provision for credit losses, partially offset by lower provision for income taxes.

 

Net interest income decreased $0.3 million, or 1%, from the comparable year-ago period. Driving this variance were a $10.1 million increase in wholesale funding costs and $14.8 million of lower revenue from derivatives activities, offset by higher interest income in the Huntington Capital Markets margin and $21 million of higher interest income on securities.

 

The provision for credit losses was $2.5 million higher than the year-ago period, attributable to increased Huntington Capital Markets lending activity.

 

Non-interest income was $3.6 million, or 9%, lower than in the year-ago period, reflecting the impact of using securities losses to offset MSR impairment recoveries.

 

Non-interest expense for operational, administrative, and support groups, which was not specifically allocated to other business segments increased $14.7 million from last year, including $5.5 million of higher incentive plan costs, $5.8 million of other expense attributable to costs related to investments in partnerships generating tax benefits, and higher sales incentives of $2.4 million in Huntington Capital Markets.

 

The provision for income taxes declined $9.4 million, reflecting the benefit of the company’s lower overall effective tax rate versus the 35% effective tax rate used to allocate provision for income taxes to each line of business, partially offset by the company’s higher total effective tax rate in the first six months of 2004 versus the comparable year-ago period.

 

69


Table of Contents

Table 21 - Treasury/Other(1)

 

    2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

    1H04 vs. 1H03

 
    Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

    Amount

    %

 

INCOME STATEMENT (in thousands)

                                                                   

Net Interest Income

  $ 18,557     $ 25,543     $ 20,511     $ (1,954 )   -9.5 %   $ 44,100     $ 44,446     $ (346 )   -0.8 %

Provision for credit losses

    61       2,393       (66 )     127     NM       2,454       (60 )     2,514     NM  
   


 


 


 


 

 


 


 


 

Net Interest Income After Provision for Credit Losses

    18,496       23,150       20,577       (2,081 )   -10.1 %     41,646       44,506       (2,860 )   -6.4 %
   


 


 


 


 

 


 


 


 

Service charges on deposit accounts

    7       10       10       (3 )   -30.0 %     17       22       (5 )   -22.7 %

Brokerage and insurance income

    185       215       216       (31 )   -14.4 %     400       439       (39 )   -8.9 %

Mortgage banking

    10,199       (10,200 )     —         10,199     NM       (1 )     —         (1 )   NM  

Bank Owned Life Insurance income

    11,309       10,485       11,043       266     2.4 %     21,794       22,180       (386 )   -1.7 %

Other

    2,701       5,904       5,818       (3,117 )   -53.6 %     8,605       8,887       (282 )   -3.2 %
   


 


 


 


 

 


 


 


 

Total Non-Interest Income Before Securities Gains

    24,401       6,414       17,087       7,314     42.8 %     30,815       31,528       (713 )   -2.3 %

Securities gains

    (9,949 )     15,090       6,921       (16,870 )   NM       5,141       8,076       (2,935 )   -36.3 %
   


 


 


 


 

 


 


 


 

Total Non-Interest Income

    14,452       21,504       24,008       (9,556 )   -39.8 %     35,956       39,604       (3,648 )   -9.2 %
   


 


 


 


 

 


 


 


 

Total Non-Interest Expense

    19,986       17,732       7,679       12,307     NM       37,718       23,050       14,668     63.6 %
   


 


 


 


 

 


 


 


 

Income Before Provision for Income Taxes

    12,962       26,922       36,906       (23,944 )   -64.9 %     39,884       61,060       (21,176 )   -34.7 %

Provision for income taxes (2)

    (5,809 )     (4,352 )     2,985       (8,794 )   NM       (10,161 )     (758 )     (9,403 )   NM  
   


 


 


 


 

 


 


 


 

Net Income - Operating (1)

  $ 18,771     $ 31,274     $ 33,921     $ (15,150 )   -44.7 %   $ 50,045     $ 61,818     $ (11,773 )   -19.0 %
   


 


 


 


 

 


 


 


 

Revenue - Fully Taxable Equivalent (FTE)

                                                                   

Net Interest Income

  $ 18,557     $ 25,543     $ 20,511     $ (1,954 )   -9.5 %   $ 44,100     $ 44,446     $ (346 )   -0.8 %

Tax Equivalent Adjustment (2)

    2,660       2,765       1,755       905     51.6 %     5,425       3,505       1,920     54.8 %
   


 


 


 


 

 


 


 


 

Net Interest Income (FTE)

    21,217       28,308       22,266       (1,049 )   -4.7 %     49,525       47,951       1,574     3.3 %

Non-Interest Income

    14,451       21,504       24,008       (9,557 )   -39.8 %     35,955       39,604       (3,649 )   -9.2 %
   


 


 


 


 

 


 


 


 

Total Revenue (FTE)

  $ 35,668     $ 49,812     $ 46,274     $ (10,606 )   -22.9 %   $ 85,480     $ 87,555     $ (2,075 )   -2.4 %
   


 


 


 


 

 


 


 


 

Total Revenue Excluding Securities Gains (FTE)

  $ 45,617     $ 34,722     $ 39,353     $ 6,264     15.9 %   $ 80,339     $ 79,479     $ 860     1.1 %
   


 


 


 


 

 


 


 


 

SELECTED AVERAGE BALANCES (in millions)

                                                                   

Securities

  $ 5,233     $ 5,045     $ 3,495     $ 1,737     49.7 %   $ 5,139     $ 3,310     $ 1,829     55.3 %

Loans:

                                                                   

C&I

  $ 102     $ 70     $ 52     $ 50     96.2 %   $ 86     $ 17     $ 69     NM  

CRE

                                                                   

Construction

    1       0       (1 )     2     NM       1       19       (18 )   -94.7 %

Commercial

    59       62       61       (2 )   -3.3 %     61       75       (14 )   -18.7 %
   


 


 


 


 

 


 


 


 

Total Loans

  $ 162     $ 132     $ 112     $ 50     44.6 %   $ 148     $ 111     $ 37     33.3 %
   


 


 


 


 

 


 


 


 

Deposits:

                                                                   

Brokered time deposits and negotiable CDs

    1,737       1,907       1,241       496     40.0 %     1,822       1,198       624     52.1 %

Foreign time deposits

    97       101       80       17     21.3 %     99       138       (39 )   -28.3 %
   


 


 


 


 

 


 


 


 

Total Deposits

  $ 1,834     $ 2,008     $ 1,321     $ 513     38.8 %   $ 1,921     $ 1,336     $ 585     43.8 %
   


 


 


 


 

 


 


 


 


(1) Operating basis, see page 50 for definition.
(2) Reconciling difference between company’s actual effective tax rate and 35% tax rate allocated to each business segment.

NM, not a meaningful value.

 

70


Table of Contents

Table 21 - Treasury/Other(1)

 

    2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

    1H04 vs. 1H03

 
    Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

    Amount

    %

 

PERFORMANCE METRICS

                                                                   

Return on average assets

    1.07 %     1.87 %     2.62 %     -1.55 %           1.45 %     2.49 %     -1.04 %      

Return on average equity

    9.8 %     17.8 %     22.9 %     -13.1 %           13.6 %     20.3 %     -6.7 %      

Net interest margin

    1.53 %     2.13 %     2.37 %     -0.84 %           1.82 %     2.71 %     -0.89 %      

Efficiency ratio

    43.8 %     51.1 %     19.5 %     24.3 %           46.9 %     29.0 %     17.9 %      

CREDIT QUALITY

                                                                   

Net Charge-offs by Loan Type (in thousands)

                                                                   

C&I

  $ (23 )   $ —       $ —       $ (23 )   NM     $ (23 )   $ —       $ (23 )   NM  

CRE

    1,999       1       —         1,999     NM       2,000       —         2,000     NM  
   


 


 


 


 

 


 


 


 

Total commercial

    1,976       1       —         1,976     NM       1,977       —         1,977     NM  
   


 


 


 


 

 


 


 


 

Total Net Charge-offs

  $ 1,976     $ 1     $ —       $ 1,976     NM     $ 1,977     $ —       $ 1,977     NM  
   


 


 


 


 

 


 


 


 

Net Charge-offs - annualized percentages

                                                                   

C&I

    -0.09 %     0.00 %     0.00 %     -0.09 %           -0.05 %     0.00 %     -0.05 %      

CRE

    13.40 %     0.01 %     0.00 %     13.40 %           6.47 %     0.00 %     6.47 %      
   


 


 


 


 

 


 


 


 

Total commercial

    4.91 %     0.00 %     0.00 %     4.91 %           2.68 %     0.00 %     2.68 %      
   


 


 


 


 

 


 


 


 

Total Net Charge-offs

    4.91 %     0.00 %     0.00 %     4.91 %           2.68 %     0.00 %     2.68 %      
   


 


 


 


 

 


 


 


 

Non-performing Assets (NPA) (in millions)

                                                                   

C&I

  $ —       $ 1     $ 1     $ (1 )   -100.0 %   $ —       $ 1     $ (1 )   -100.0 %

CRE

    8       11       —         8     NM       8       —         8     NM  

Total Non-accrual Loans

    8       12       1       7     NM       8       1       7     NM  

Renegotiated loans

    —         —         —         —       NM       —         —         —       NM  
   


 


 


 


 

 


 


 


 

Total Non-performing Loans (NPL)

    8       12       1       7     NM       8       1       7     NM  

Other real estate, net (OREO)

    (1 )     (1 )     —         (1 )   NM       (1 )     —         (1 )   NM  
   


 


 


 


 

 


 


 


 

Total Non-performing Assets

  $ 7     $ 11     $ 1     $ 6     NM     $ 7     $ 1     $ 6     NM  
   


 


 


 


 

 


 


 


 

Accruing loans past due 90 days or more

  $ —       $ —       $ —       $ —       NM     $ —       $ —       $ —       NM  

Allowance for Loan and Lease Losses (ALLL)(eop)

  $ 42     $ 77     $ 39     $ 3     7.7 %   $ 42     $ 39     $ 3     7.7 %

ALLL as a % of total loans and leases

    29.79 %     53.47 %     20.97 %     8.82 %           29.79 %     20.97 %     8.82 %      

ALLL as a % of NPLs

    NM       NM       NM       NM             NM       NM       NM        

ALLL + OREO as a % of NPAs

    NM       NM       NM       NM             NM       NM       NM        

NPLs as a % of total loans and leases

    5.67 %     8.33 %     0.54 %     5.13 %           5.67 %     0.54 %     5.13 %      

NPAs as a % of total loans and leases + OREO

    5.00 %     7.69 %     0.54 %     4.46 %           5.00 %     0.54 %     4.46 %      

SUPPLEMENTAL DATA

                                                                   

# employees - full-time equivalent (eop)

    1,975       1,956       2,016       (41 )   -2.0 %     1,975       2,016       (41 )   -2.0 %

(1) Operating basis, see page 50 for definition.
NM, not a meaningful value.
eop, end of period.


Table of Contents

Table 22 - Total Company (1)

 

     2004

    2004

    2003

   2Q04 vs. 2Q03

    2004

   2003

   1H04 vs. 1H03

 
     Second

    First

    Second

   Amount

    %

    6 Months

   6 Months

   Amount

     %

 

INCOME STATEMENT (in thousands)

                                                                  

Net Interest Income

   $ 222,563     $ 222,685     $ 202,441    $ 20,122     9.9 %   $ 445,248    $ 404,200    $ 41,048      10.2 %

Provision for credit losses

     5,027       25,596       49,193      (44,166 )   -89.8 %     30,623      86,037      (55,414 )    -64.4 %
    


 


 

  


 

 

  

  


  

Net Interest Income After Provision for Credit Losses

     217,536       197,089       153,248      64,288     42.0 %     414,625      318,163      96,462      30.3 %
    


 


 

  


 

 

  

  


  

Operating lease income

     78,706       88,867       128,574      (49,868 )   -38.8 %     167,573      266,767      (99,194 )    -37.2 %

Service charges on deposit accounts

     43,596       41,837       40,914      2,682     6.6 %     85,433      80,783      4,650      5.8 %

Brokerage and insurance income

     13,523       15,197       14,196      (673 )   -4.7 %     28,720      29,693      (973 )    -3.3 %

Trust services

     16,708       16,323       15,580      1,128     7.2 %     33,031      30,491      2,540      8.3 %

Mortgage banking

     23,322       (4,296 )     7,185      16,137     NM       19,026      18,310      716      3.9 %

Bank Owned Life Insurance income

     11,309       10,485       11,043      266     2.4 %     21,794      22,180      (386 )    -1.7 %

Other service charges and fees

     10,645       9,513       11,372      (727 )   -6.4 %     20,158      21,710      (1,552 )    -7.1 %

Other

     24,659       25,619       27,704      (3,045 )   -11.0 %     50,278      48,105      2,173      4.5 %
    


 


 

  


 

 

  

  


  

Total Non-Interest Income Before Securities Gains

     222,468       203,545       256,568      (34,100 )   -13.3 %     426,013      518,039      (92,026 )    -17.8 %

Securities gains

     (9,230 )     15,090       6,887      (16,117 )   NM       5,860      8,085      (2,225 )    -27.5 %
    


 


 

  


 

 

  

  


  

Total Non-Interest Income

     213,238       218,635       263,455      (50,217 )   -19.1 %     431,873      526,124      (94,251 )    -17.9 %
    


 


 

  


 

 

  

  


  

Operating lease expense

     62,563       70,710       102,939      (40,376 )   -39.2 %     133,273      214,527      (81,254 )    -37.9 %

Personnel costs

     119,715       121,624       105,242      14,473     13.8 %     241,339      218,331      23,008      10.5 %

Other

     99,875       93,320       94,167      5,708     6.1 %     193,195      185,969      7,226      3.9 %
    


 


 

  


 

 

  

  


  

Total Non-Interest Expense

     282,153       285,654       302,348      (20,195 )   -6.7 %     567,807      618,827      (51,020 )    -8.2 %
    


 


 

  


 

 

  

  


  

Income Before Provision for Income Taxes

     148,621       130,070       114,355      34,266     30.0 %     278,691      225,460      53,231      23.6 %

Provision for income taxes

     41,672       31,750       30,092      11,580     38.5 %     73,422      56,783      16,639      29.3 %
    


 


 

  


 

 

  

  


  

Net Income - Operating (1)

   $ 106,949     $ 98,320     $ 84,263    $ 22,686     26.9 %   $ 205,269    $ 168,677    $ 36,592      21.7 %
    


 


 

  


 

 

  

  


  

Revenue - Fully Taxable Equivalent (FTE)

                                                                  

Net Interest Income

   $ 222,563     $ 222,685     $ 202,441    $ 20,122     9.9 %   $ 445,248    $ 404,200    $ 41,048      10.2 %

Tax Equivalent Adjustment (2)

     2,919       3,023       2,076      843     40.6 %     5,942      4,172      1,770      42.4 %
    


 


 

  


 

 

  

  


  

Net Interest Income (FTE)

     225,482       225,708       204,517      20,965     10.3 %     451,190      408,372      42,818      10.5 %

Non-Interest Income

     213,238       218,635       263,455      (50,217 )   -19.1 %     431,873      526,124      (94,251 )    -17.9 %
    


 


 

  


 

 

  

  


  

Total Revenue (FTE)

   $ 438,720     $ 444,343     $ 467,972    $ (29,252 )   -6.3 %   $ 883,063    $ 934,496    $ (51,433 )    -5.5 %
    


 


 

  


 

 

  

  


  

Total Revenue Excluding Securities Gains (FTE)

   $ 447,950     $ 429,253     $ 461,085    $ (13,135 )   -2.8 %   $ 877,203    $ 926,411    $ (49,208 )    -5.3 %
    


 


 

  


 

 

  

  


  

SELECTED AVERAGE BALANCES (in millions)

                                                                  

Loans:

                                                                  

C&I

   $ 5,536     $ 5,365     $ 5,626    $ (90 )   -1.6 %   $ 5,451    $ 5,625    $ (174 )    -3.1 %

CRE

                                                                  

Construction

     1,322       1,322       1,239      83     6.7 %     1,322      1,214      108      8.9 %

Commercial

     2,906       2,876       2,621      285     10.9 %     2,891      2,593      298      11.5 %

Consumer

                                                                  

Auto leases - indirect

     2,139       1,988       1,306      833     63.8 %     2,064      1,153      911      79.0 %

Auto loans - indirect

     2,337       3,041       2,830      (493 )   -17.4 %     2,689      2,954      (265 )    -9.0 %

Home equity loans & lines of credit

     4,142       3,880       3,359      783     23.3 %     4,011      3,298      713      21.6 %

Residential mortgage

     2,986       2,674       1,887      1,099     58.2 %     2,830      1,859      971      52.2 %

Other loans

     399       356       379      20     5.3 %     377      383      (6 )    -1.6 %
    


 


 

  


 

 

  

  


  

Total Consumer

     12,003       11,939       9,761      2,242     23.0 %     11,971      9,647      2,324      24.1 %
    


 


 

  


 

 

  

  


  

Total Loans

   $ 21,767     $ 21,502     $ 19,247    $ 2,520     13.1 %   $ 21,635    $ 19,079    $ 2,556      13.4 %
    


 


 

  


 

 

  

  


  

Operating lease assets

   $ 977     $ 1,166     $ 1,802    $ (825 )   -45.8 %   $ 1,070    $ 1,937    $ (867 )    -44.8 %

Deposits:

                                                                  

Non-interest bearing deposits

   $ 3,223     $ 3,017     $ 3,046    $ 177     5.8 %   $ 3,120    $ 2,984    $ 136      4.6 %

Interest bearing demand deposits

     7,168       6,609       6,100      1,068     17.5 %     6,889      5,868      1,021      17.4 %

Savings deposits

     2,839       2,819       2,804      35     1.2 %     2,829      2,788      41      1.5 %

Domestic time deposits

     3,795       3,824       4,279      (484 )   -11.3 %     3,810      4,347      (537 )    -12.4 %

Brokered time deposits and negotiable CDs

     1,737       1,907       1,241      496     40.0 %     1,822      1,198      624      52.1 %

Foreign time deposits

     542       549       426      116     27.2 %     545      470      75      16.0 %
    


 


 

  


 

 

  

  


  

Total Deposits

   $ 19,304     $ 18,725     $ 17,896    $ 1,408     7.9 %   $ 19,015    $ 17,655    $ 1,360      7.7 %
    


 


 

  


 

 

  

  


  


(1) Operating basis, see page 50 for definition.
(2) Calculated assuming a 35% tax rate.
NM, not a meaningful value.

 

72


Table of Contents

Table 22 - Total Company (1)

 

     2004

    2004

    2003

    2Q04 vs. 2Q03

    2004

    2003

     1H04 vs. 1H03

 
     Second

    First

    Second

    Amount

    %

    6 Months

    6 Months

     Amount

     %

 

PERFORMANCE METRICS

                                                                      

Return on average assets

     1.37 %     1.28 %     1.20 %     0.17 %           1.33 %     1.23 %      0.10 %       

Return on average equity

     18.5 %     17.4 %     15.7 %     2.8 %           17.9 %     15.8 %      2.1 %       

Net interest margin

     3.29 %     3.36 %     3.47 %     -0.18 %           3.32 %     3.52 %      -0.20 %       

Efficiency ratio

     63.0 %     66.5 %     65.6 %     -2.6 %           64.7 %     66.8 %      -2.1 %       

CREDIT QUALITY (in thousands)

                                                                      

Net Charge-offs by Loan Type

                                                                      

C&I

   $ (2,803 )   $ 5,956     $ 26,546     $ (29,349 )   NM     $ 3,153     $ 41,450      $ (38,297 )    -92.4 %

CRE

     2,940       1,637       607       2,333     NM       4,577       1,153        3,424      NM  
    


 


 


 


 

 


 


  


  

Total commercial

     137       7,593       27,153       (27,016 )   -99.5 %     7,730       42,603        (34,873 )    -81.9 %

Consumer

                                                                      

Auto leases

     2,159       3,159       1,422       737     51.8 %     5,318       2,342        2,976      NM  

Auto loans

     5,604       13,422       7,524       (1,920 )   -25.5 %     19,026       18,147        879      4.8 %

Home equity loans & lines of credit

     3,019       3,116       3,671       (652 )   -17.8 %     6,135       7,724        (1,589 )    -20.6 %

Residential mortgage

     302       316       267       35     13.1 %     618       412        206      50.0 %

Other loans

     1,294       1,021       1,019       275     27.0 %     2,315       2,664        (349 )    -13.1 %
    


 


 


 


 

 


 


  


  

Total consumer

     12,378       21,034       13,903       (1,525 )   -11.0 %     33,412       31,289        2,123      6.8 %
    


 


 


 


 

 


 


  


  

Total Net Charge-offs

   $ 12,515     $ 28,627     $ 41,056     $ (28,541 )   -69.5 %   $ 41,142     $ 73,892      $ (32,750 )    -44.3 %
    


 


 


 


 

 


 


  


  

Net Charge-offs - annualized percentages

                                                                      

C&I

     -0.20 %     0.44 %     1.89 %     -2.09 %           0.12 %     1.47 %      -1.35 %       

CRE

     0.28 %     0.16 %     0.06 %     0.22 %           0.22 %     0.06 %      0.16 %       
    


 


 


 


       


 


  


      

Total commercial

     0.01 %     0.32 %     1.14 %     -1.13 %           0.16 %     0.90 %      -0.74 %       

Consumer

                                                                      

Auto leases

     0.40 %     0.64 %     0.44 %     -0.04 %           0.52 %     0.40 %      0.12 %       

Auto loans

     0.96 %     1.77 %     1.06 %     -0.10 %           1.42 %     1.23 %      0.19 %       

Home equity loans & lines of credit

     0.29 %     0.32 %     0.44 %     -0.15 %           0.31 %     0.47 %      -0.17 %       

Residential mortgage

     0.04 %     0.05 %     0.06 %     -0.02 %           0.04 %     0.04 %      0.00 %       

Other loans

     1.30 %     1.15 %     1.08 %     0.22 %           1.23 %     1.39 %      -0.16 %       
    


 


 


 


       


 


  


      

Total consumer

     0.41 %     0.70 %     0.57 %     -0.16 %           0.56 %     0.65 %      -0.09 %       
    


 


 


 


       


 


  


      

Total Net Charge-offs

     0.23 %     0.53 %     0.85 %     -0.62 %           0.38 %     0.77 %      -0.39 %       
    


 


 


 


       


 


  


      

Non-performing Assets (NPA) (in millions)

                                                                      

C&I

   $ 32     $ 45     $ 86     $ (54 )   -62.8 %   $ 32     $ 86      $ (54 )    -62.8 %

CRE

     16       20       22       (6 )   -27.3 %     16       22        (6 )    -27.3 %

Residential mortgage

     14       12       12       2     16.7 %     14       12        2      16.7 %
    


 


 


 


 

 


 


  


  

Total Non-accrual Loans

     62       77       120       (58 )   -48.3 %     62       120        (58 )    -48.3 %

Renegotiated loans

     —         —         —         —       NM       —         —          —        NM  
    


 


 


 


 

 


 


  


  

Total Non-performing Loans (NPL)

     62       77       120       (58 )   -48.3 %     62       120        (58 )    -48.3 %

Other real estate, net (OREO)

     13       15       14       (1 )   -7.1 %     13       14        (1 )    -7.1 %
    


 


 


 


 

 


 


  


  

Total Non-performing Assets

   $ 75     $ 92     $ 134     $ (59 )   -44.0 %   $ 75     $ 134      $ (59 )    -44.0 %
    


 


 


 


 

 


 


  


  

Accruing loans past due 90 days or more

   $ 51     $ 60     $ 55     $ (4 )   -7.3 %   $ 51     $ 55      $ (4 )    -7.3 %

Allowance for Loan and Lease Losses (ALLL) (eop)

   $ 287     $ 295     $ 308     $ (21 )   -6.8 %   $ 287     $ 308      $ (21 )    -6.8 %

ALLL as a % of total loans and leases

     1.32 %     1.39 %     1.61 %     -0.29 %           1.32 %     1.61 %      -0.29 %       

ALLL as a % of NPLs

     464.5 %     383.0 %     256.1 %     208.4 %           464.5 %     256.1 %      208.4 %       

ALLL + OREO as a % of NPAs

     400.0 %     337.0 %     240.3 %     159.7 %           400.0 %     240.3 %      159.7 %       

NPLs as a % of total loans and leases

     0.28 %     0.36 %     0.63 %     -0.35 %           0.28 %     0.63 %      -0.35 %       

NPAs as a % of total loans and leases + OREO

     0.34 %     0.43 %     0.70 %     -0.36 %           0.34 %     0.70 %      -0.36 %       

SUPPLEMENTAL DATA

                                                                      

# employees - full-time equivalent

     8,045       7,915       7,986       59     0.7 %     8,045       7,986        59      0.7 %

(1) Operating basis, see page 50 for definition.
NM, not a meaningful value.
eop, end of period.

 

73


Table of Contents

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Quantitative and qualitative disclosures for the current period are found beginning on page 45 of this report, which includes changes in market risk exposures from disclosures presented in Huntington’s 2003 Form 10-K.

 

Item 4. Controls and Procedures

 

Huntington’s management, with the participation of its Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of Huntington’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon such evaluation, Huntington’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Huntington’s disclosure controls and procedures are effective.

 

There have not been any changes in Huntington’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) ad 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, Huntington’s internal control over financial reporting.

 

74


Table of Contents

PART II. OTHER INFORMATION

 

In accordance with the instructions to Part II, the other specified items in this part have been omitted because they are not applicable or the information has been previously reported.

 

Item 2. Changes in Securities and Use of Proceeds

 

(e)

 

Period


   Total Number of
Shares Purchased


   Average Price
Paid Per Share


   Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs


   Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs(1)


April 1, 2004 to April 30, 2004

   —      —      —      7,500,000

May 1, 2004 to May 31, 2004

   —      —      —      7,500,000

June 1, 2004 to June 30, 2004

   —      —      —      7,500,000

Total

   —      —      —      7,500,000

(1) Information is as of the end of the Period. On January 16, 2003, the Registrant announced that its board of directors had authorized the repurchase from time to time of 8,000,000 shares of the Registrant’s common stock (the “2003 Repurchase Program”). The 2003 Repurchase Program did not have an expiration date. A total of 4,100,000 shares had been repurchased under the 2003 Repurchase Program in 2003. No shares were repurchased in the 2004 first quarter under the 2003 Repurchase Program or otherwise. On April 27, 2004, the Registrant announced that its board of directors had terminated the 2003 Repurchase Program and had authorized a new program for the repurchase in the open market or through privately negotiated transactions of 7,500,000 share of the Registrant’s common stock (the “2004 Repurchase Program”). The 2004 Repurchase Program does not have an expiration date. The Registrant also intends to repurchase approximately 2.5 million shares associated with the Unizan Financial Corp. merger, and the remaining 5,000,000 shares would be repurchased from time to time whenever market conditions or other factors deem that to be appropriate.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

Huntington held its annual meeting of shareholders on April 27, 2004. At this meeting, the shareholders approved the following management proposals:

 

          For

   Against

  

Abstain/

Withheld


1.

   Election of directors to serve as Class II Directors until the 2007 Annual Meeting of Shareholders as follows:               
    

Karen A. Holbrook

   194,112,217         4,488,001
    

David P. Lauer

   193,206,154         5,394,064
    

Kathleen H. Ransier

   191,772,564         6,827,653

2.

   Election of directors to serve as Class III Directors until the 2005 Annual Meeting of Shareholders as follows:               
    

David L. Porteous

   193,539,668         5,060,550

3.

   Proposal to approve the Management Incentive Plan, as amended and restated.    138,274,325    17,081,492    3,785,422

4.

   Proposal to approve the 2004 Stock and Long-Term Incentive Plan.    130,994,537    24,550,481    3,596,216

5.

   Ratification of Deloitte & Touche LLP as independent auditors Huntington for the year 2004.    191,730,116    4,663,300    2,206,802

 

75


Table of Contents

Item 6. Exhibits and Reports on Form 8-K

 

  (a) Exhibits

 

  3(i)(a). Articles of Restatement of Charter, Articles of Amendment to Articles of Restatement of Charter, and Articles Supplementary — previously filed as Exhibit 3(i) to Annual Report on Form 10-K for the year ended December 31, 1993, and incorporated herein by reference.

 

  (i)(b). Articles of Amendment to Articles of Restatement of Charter — previously filed as Exhibit 3(i)(c) to Quarterly Report on Form 10-Q for the quarter ended March 31, 1998, and incorporated herein by reference.

 

  (ii)(a). Amended and Restated Bylaws as of July 16, 2002 – previously filed as Exhibit 3(ii) to Quarterly Report on form 10-Q for the quarter ended June 30, 2003, and incorporated herein by reference.

 

  4.(a). Instruments defining the Rights of Security Holders — reference is made to Articles Fifth, Eighth, and Tenth of Articles of Restatement of Charter, as amended and supplemented. Instruments defining the rights of holders of long-term debt will be furnished to the Securities and Exchange Commission upon request.

 

  (b). Rights Plan, dated February 22, 1990, between Huntington Bancshares Incorporated and The Huntington National Bank (as successor to The Huntington Trust Company, National Association) — previously filed as Exhibit 1 to Registration Statement on Form 8-A, filed with the Securities and Exchange Commission on February 22, 1990, and incorporated herein by reference.

 

  (c). Amendment No. 1 to the Rights Agreement, dated August 16, 1995— previously filed as Exhibit 4(b) to Form 8-K, dated August 16, 1995, and incorporated herein by reference.

 

  10(a). Huntington Bancshares Incorporated Management Incentive Plan – as amended and restated effective for plan years beginning on or after January 1, 2004.

 

  (b) Huntington Bancshares Incorporated 2004 Stock and Long-Term Incentive Plan.

 

  (c) Executive Deferred Compensation Plan of Huntington Bancshares Incorporated – as amended and restated on February 18, 2004.

 

  31.1 Sarbanes-Oxley Act 302 Certification – Chief Executive Officer

 

  31.2 Sarbanes-Oxley Act 302 Certification – Chief Financial Officer

 

  32.1 Sarbanes-Oxley Act 906 Certification - Chief Executive Officer.

 

  32.2 Sarbanes-Oxley Act 906 Certification - Chief Financial Officer.

 

  (b) Reports on Form 8-K

 

  1. A report on Form 8-K, dated April 15 2004, was filed under report item numbers 7 and 12, concerning Huntington’s results of operations for the first quarter ended March 31, 2004.

 

  2. A report on Form 8-K, dated April 20, 2004, was filed under report item number 5, regarding Huntington’s decision to terminate its Employee Stock Incentive Plan after it determined that the shares reserved for issuance of future option grants under the Plan would not be necessary following the approval of its 2004 Stock and Long-Term Incentive Plan.

 

  3. A report on Form 8-K, dated June 16, 2004, was filed under report items 5 and 7, announcing the delay in closing of the merger agreement between Huntington Bancshares Incorporated and Unizan Financial Corp.

 

76


Table of Contents

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Huntington Bancshares Incorporated

(Registrant)

 

Date: August 9, 2004

     

/s/ Thomas E. Hoaglin


       

      Thomas E. Hoaglin

       

      Chairman, Chief Executive Officer and

       

      President

Date: August 9, 2004

     

/s/ Donald R. Kimble


       

      Donald R. Kimble

       

      Chief Financial Officer and Controller

 

77