10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on August 14, 2003
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, 2003
Commission File Number 0-2525
HUNTINGTON BANCSHARES INCORPORATED
MARYLAND 31-0724920
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) 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 228,693,313 shares of Registrant's without par value common stock
outstanding on July 31, 2003.
HUNTINGTON BANCSHARES INCORPORATED
INTRODUCTORY NOTE
On July 17, 2003, Huntington Bancshares Incorporated (Huntington) announced it
was voluntarily restating prior period results to reflect a series of actions
related to the timing of recognition of origination fees paid to automobile
dealers, commissions paid to employees for deposit gathering activities, certain
residential mortgage loan origination fee income, expense related to pension
settlements, and reserves related to the sale of an automobile debt cancellation
product. The financial impact related to these actions is reflected in the
second quarter financial information included in this report and, for previously
reported periods, is summarized in Part II, Item 5 of this report. Huntington
also stated it would defer origination fees and expenses prospectively for all
loans and leases originated after June 30, 2003.
In addition, Huntington announced that it is reviewing the application of SFAS
91 (Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Cost of Leases) on historical results. SFAS
91 deals with the timing of recognition of loan and lease origination fees and
certain expenses, and requires that such fees and costs, if material, be
deferred and amortized over the estimated life of the asset.
Part II, Item 5 also contains additional disclosures which have no financial
impact on previously reported results, but which will be included in the second
amended 2002 Annual Report on Form 10-K/A and/or the amended 2003 First Quarter
10-Q/A. Huntington is not filing these amended documents at this time because it
has not completed gathering and analyzing data for 1995-1997, which is necessary
to finalize its review of the impact of not having deferred net origination fees
and costs on prior period results. However, based upon information currently
available, Huntington expects the majority of any additional impact that might
result from a restatement for the deferral of all loan origination fees and
costs would be reflected in 1999 and earlier periods, similar to the timing
impact of the restatements announced on July 17, 2003.
INDEX
2
See notes to unaudited consolidated financial statements.
3
See notes to unaudited consolidated financial statements.
4
See notes to unaudited consolidated financial statements.
5
See notes to unaudited consolidated financial statements.
6
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited 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 consolidated financial statements have been prepared according
to the rules and regulations of the Securities and Exchange Commission and,
therefore, certain information and footnote disclosures normally included in
annual 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 amended 2002
Annual Report on Form 10-K/A filed on May 20, 2003 (amended Form 10-K/A), 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.
In preparing financial statements in conformity with GAAP, management of
Huntington is required to make estimates, assumptions, and judgments that affect
the reported amounts of assets and liabilities as of the date of the balance
sheet and reported amounts of revenue and expenses during the reporting period.
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. Actual results could differ from those estimates.
Certain amounts in the prior year's financial statements have been
reclassified to conform to the 2003 presentation.
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45).
This Interpretation changes current practice in the accounting for, and
disclosure of, guarantees which, for Huntington, apply generally to its standby
letters of credit. The Interpretation requires certain guarantees to be recorded
at fair value, which differs from the prior practice of recording a liability
generally when a loss is probable and reasonably estimable, as those terms are
defined in FASB Statement No. 5, Accounting for Contingencies. The
Interpretation also requires a guarantor to make significant new disclosures,
even when the likelihood of making any payments under the guarantee is remote,
which also differs from current practice. The recognition requirements of this
Interpretation were adopted prospectively January 1, 2003. The impact of
adopting FIN 45 was not material.
In December 2002, the FASB issued Statement No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure. This Statement amends
Statement No. 123, Accounting for Stock-Based Compensation, to provide
alternative methods of transition to Statement No. 123's fair value method of
accounting for stock-based employee compensation. Statement No. 148 also amends
the disclosure provisions of Statement 123 and Accounting Principles Board (APB)
Opinion No. 28, Interim Financial Reporting, to require disclosure 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 Statement No. 148 does not amend Statement No. 123
to require companies to account for employee stock options using the fair value
method, the disclosure provisions of Statement No. 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 Statement No. 123
or the intrinsic value method of APB Opinion No. 25, which is the method
currently used by Huntington.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46). This Interpretation of Accounting Research
Bulletin No. 51 (ARB 51), Consolidated Financial Statements, addresses
consolidation by business enterprises where ownership interests in an entity may
vary over time or, in many cases, of special-purpose entities (SPEs). To be
consolidated for financial reporting, these entities must have certain
characteristics. ARB 51 requires that an enterprise's consolidated financial
statements include subsidiaries in which the enterprise has a controlling
financial interest. This Interpretation requires existing unconsolidated
variable interest entities to be consolidated by their primary beneficiaries if
the entities do not effectively disperse risks among parties involved. An
enterprise that holds significant variable interests in such an entity, but is
not the primary beneficiary, is required to disclose certain information
regarding its interests in that entity. This Interpretation applies in the first
fiscal year or interim period beginning after June 15, 2003, to variable
interest entities in which an enterprise holds an interest that it acquired
before February 1, 2003. It also applies immediately to variable interest
entities created after January 31, 2003, and to variable interest entities in
which an enterprise obtains an interest after that date. This Interpretation may
be applied (1) prospectively with a cumulative effect adjustment as of the date
on which it is first applied, or (2) by restating previously
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issued financial statements for one or more years with a cumulative effect
adjustment as of the beginning of the first year restated.
Effective July 1, 2003, Huntington adopted FIN 46 resulting in the
consolidation of one of the securitization trusts formed in 2000. The
consolidation of that trust involved recognition of the trust's assets and
liabilities, elimination of the related retained interest and servicing asset,
recognition of other related assets, and establishment of a 1.01% allowance for
loan and lease losses. Reflecting these impacts, the adoption of FIN 46 will
result in a cumulative effect charge of approximately $11 million, or $0.05 per
share, in the third quarter, a reduction of the ALLL by approximately 3 basis
points, and a reduction of the tangible common equity ratio of approximately 30
basis points. Regulatory capital was minimally impacted since these assets were
reflected previously in risk-based assets.
Huntington owns the common stock of two fully-consolidated subsidiary
business trusts, which have issued company-obligated mandatorily redeemable
preferred capital securities to third party investors. The trusts' only assets,
which totaled $300 million at June 30, 2003, are debentures issued by
Huntington, which were acquired by the trusts using proceeds from the issuance
of the preferred securities and common stock. With the implementation of FIN 46
in the third quarter of 2003, Huntington will no longer consolidate these
trusts. Upon de-consolidation, Huntington will include the debentures in other
long-term debt and Huntington's equity interest in the trusts will be included
in "accrued income and other assets" on the balance sheet. For regulatory
reporting purposes, the Federal Reserve Board has advised that such preferred
securities will continue to constitute Tier 1 capital until further notice.
In April 2003, the FASB issued Statement No. 149, Amendment of Statement
133 on Derivative Instruments and Hedging Activities. This Statement amends and
clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as derivatives) and for hedging activities under
Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.
The changes in this Statement improve financial reporting by requiring that
contracts with comparable characteristics be accounted for similarly. In
particular, this Statement (1) clarifies under what circumstances a contract
with an initial net investment meets the characteristic of a derivative
discussed in paragraph 6(b) of Statement No. 133, (2) clarifies when a
derivative contains a financing component, (3) amends the definition of an
"underlying" to conform it to language used in FIN 45, and (4) amends certain
other existing pronouncements. Those changes will result in more consistent
reporting of contracts as either derivatives or hybrid instruments. This
Statement is substantially effective on a prospective basis for contracts
entered into or modified after June 30, 2003. Huntington is in the process of
assessing the impact of Statement No. 149 on its results of operations and
financial condition.
In May 2003, the FASB issued Statement No. 150, Accounting for Certain
Financial Instruments with characteristics of both Liabilities and Equity. This
Statement establishes standards for how an issuer such as Huntington classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
Some of the provisions of this Statement are consistent with the current
definition of liabilities in FASB Concepts Statement No. 6, Elements of
Financial Statements. The remaining provisions of this Statement are consistent
with the Board's proposal to revise that definition to encompass certain
obligations that a reporting entity can or must settle by issuing its own equity
shares, depending on the nature of the relationship established between the
holder and the issuer. This Statement does not apply to features that are
embedded in a financial instrument that is not a derivative in its entirety.
This Statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. Huntington is in the process of
assessing the impact of Statement No. 150 on its results of operations and
financial condition.
Statement of Financial Accounting Standards No. 91, Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases, (SFAS 91) deals with the timing of recognition
of loan and lease origination fees and certain expenses. The statement requires
that such fees and costs, if material, be deferred and amortized over the
estimated life of the asset. Generally, Huntington records the fees it receives
from loan and lease origination activities, as well as the cost of those
activities, in the period in which the fees are received and the costs incurred.
Effective July 1, 2003, Huntington elected to defer loan origination fees and
related costs prospectively for all loan and lease originations. Management
believes that the deferral of all loan and origination fees will reduce reported
income per share by $0.05 in the second half of 2003. Huntington is reviewing
whether it is appropriate to restate prior periods to reflect the deferral of
origination fees and costs. If prior years are restated, the impact on earnings
for the second half of 2003 would be less.
8
NOTE 3 - RESTATEMENTS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Huntington has voluntarily restated its prior period financial results
to reflect a series of actions related to the timing and recognition of
origination fees paid to automobile dealers, commissions paid to originate
deposits, mortgage origination fee income, and expense related to pension
settlements, and reserves related to the sale of an automobile debt cancellation
product. In addition, Huntington reclassified certain tax consulting expenses
from income tax expense to professional services.
The following table reflects the financial statement line items in
Huntington's balance sheets and income statements, showing the previously
reported financial information included in the Form 10-K/A filed on May 20, 2003
and the related restated amounts.
9
Restated financial information for prior periods has been summarized in
Part II Item 5 of this report. Financial information included in this report for
the three and six months ended June 30, 2002, has also been restated. Net income
was reduced by $0.9 million for the three-month period and increased by $2.0
million, or $0.01 per share, for the six-month period. Total loans and leases
were reduced by $24.0 million, other assets by $14.2 million, other liabilities
by $10.7 million and retained earnings by $27.5 million at June 30, 2002, for
the cumulative effect of the restatement.
NOTE 4 - RESTRUCTURING CHARGES
During the second quarter 2003, Huntington released $5.3 million of
restructuring reserves through a credit to the restructuring charge line of
non-interest expense in the accompanying unaudited consolidated financial
statements. Released reserves of $3.8 million related to those established in
1998 and $1.5 million related to the strategic refocusing plan established in
2001 and 2002. Reserves of $1.0 million and $7.2 million were released in the
first quarter of 2003 and the fourth quarter of 2002, respectively, also related
to the strategic refocusing plan. The 1998 reserve was established for, among
other items, the exit of under performing product lines, including possible
third party claims related to these exits. Management reviewed this reserve and
determined that future claims would be immaterial, and reduced the level of the
reserve accordingly.
During the first quarter of 2002, Huntington recorded pre-tax
restructuring charges of $56.2 million related to the implementation of
strategic initiatives announced July 2001. These charges included expenses of
$32.7 million related to the sale of the Florida operations, $8.0 million for
asset impairment, $4.3 million for the exit of certain e-commerce activities,
$1.8 million related to facilities, and $9.4 million for other costs. These
charges amounted to $36.5 million, or $0.14 per share, on an after-tax basis and
are reflected in Non-interest expense in the accompanying unaudited consolidated
financial statements.
As of June 30, 2003, Huntington has remaining reserves for restructuring
of $0.3 million related to the 1998 strategic initiative, and $9.1 million
related to the 2001 strategic initiatives, respectively. Huntington expects that
this remaining reserve will be adequate to fund the remaining estimated future
cash outlays that are expected in the completion of the exit activities
contemplated by Huntington's 2001 strategic refocusing plan.
10
NOTE 5- SECURITIES AVAILABLE FOR SALE
Securities available for sale at June 30, 2003 and December 31, 2002
were as follows:
NOTE 6 - OPERATING LEASE ASSETS
Operating lease assets at June 30, 2003 and 2002 and December 31, 2002,
were as follows:
Depreciation expense related to leased automobiles was $89.8 million and
$119.6 million for the three months ended June 30, 2003 and 2002, respectively.
For the respective six-month periods, depreciation expense was $187.9 million
and $243.6 million.
11
NOTE 7 - 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:
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 5.1 million and 3.1 million stock options were outstanding
at June 30, 2003 and 2002, 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 $23.73 per share and $26.60 per share at the end of
the same respective periods.
At June 30, 2003, a total of 535,337 common shares associated with a
2002 acquisition were held in escrow, subject to future issuance contingent upon
meeting certain contractual performance criteria. These shares, which were
included in treasury stock, will be included in the computation of basic and
diluted earnings per share at the beginning of the period when all conditions
necessary for their issuance have been met. Dividends paid on these shares are
reinvested in common stock.
NOTE 8 - COMPREHENSIVE INCOME
The components of Huntington's Other Comprehensive Income are the
unrealized gains (losses) on securities available for sale, unrealized gains
(losses) on derivative instruments used in cash flow hedging relationships, and
12
minimum pension liability. The related before and after tax amounts in each of
the three and six months ended June 30 were as follows:
Activity in Accumulated Other Comprehensive Income for the six months
ended June 30, 2003 and 2002 was as follows:
NOTE 9 - 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.
In December 2002, the FASB issued Statement No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure. This Statement amends
Statement No. 123, Accounting for Stock-Based Compensation, to provide
13
alternative methods of transition to Statement No. 123's fair value method of
accounting for stock-based employee compensation. Statement No. 148 also amends
the disclosure provisions of Statement 123 and APB Opinion No. 28, Interim
Financial Reporting, 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 Statement No. 148 does
not amend Statement No. 123 to require companies to account for employee stock
options using the fair value method, the disclosure provisions of Statement No.
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 Statement No. 123 or the intrinsic value method of APB Opinion No. 25.
Huntington expects to adopt the fair value method of recording stock
options under the transitional guidance of Statement No. 148. Huntington is
currently evaluating which of the three methods under the transitional guidance
it will adopt.
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 the three and
six month periods presented:
NOTE 10 - 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 function 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.
Accounting policies for the lines of business are the same as those used
in the preparation of the unaudited consolidated financial statements with
respect to activities specifically attributable to each business line. However,
the preparation of business line results requires management to establish
methodologies to allocate funding costs and benefits, expenses, and other
financial elements to each line of business. Changes are made in these
methodologies utilized for
14
certain balance sheet and income statement allocations performed by Huntington's
management reporting system, as appropriate. Prior periods are typically not
restated for these changes.
The chief decision-makers for Huntington rely on "operating earnings"
for review of performance and for critical decision-making purposes. Operating
earnings adjust net income as reported to exclude the 2002 gain from the sale of
the Florida operations, the historical Florida banking and insurance operating
results, and restructuring charges or release of previously established
restructuring reserves. See Note 10 to the unaudited consolidated financial
statements for further discussions regarding the 2002 restructuring charges and
Note 11 regarding the 2002 sale of the Florida banking and insurance operations.
The reconciling items between operating earnings and net income as reported are
presented on an after-tax basis.
Operating earnings that were previously reported have been restated,
where appropriate, to reflect a change in the timing of certain revenues and
expenses. See Note 3 to the unaudited consolidated financial statements for
further discussion regarding this restatement.
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. This segment's products include home equity loans, first
mortgage loans, direct installment loans, business loans, personal and business
deposit products, as well as sales of investment and insurance services. These
products and services are offered in six operating regions within the five
states of Ohio, Michigan, Indiana, West Virginia, and Kentucky through
Huntington's traditional banking network, Direct Bank--Huntington's customer
service center, and Web Bank at www.huntington.com. Regional Banking also
represents middle-market and large commercial banking relationships which use a
variety of banking products and services including, but not limited to,
commercial loans, commercial real estate loans, international trade, and cash
management.
DEALER SALES
This segment finances the purchase of automobiles by customers of automotive
dealerships, purchases automobiles from dealers and simultaneously leases the
automobile under long-term operating and direct financing leases, finances the
dealership's inventory of automobiles, and provides other banking services to
the automotive dealerships and their owners.
PRIVATE FINANCIAL GROUP (PFG)
This segment provides products and services designed to meet the needs of
Huntington's higher wealth customers. Revenue is derived through the sale of
personal trust, asset management, investment advisory, brokerage, insurance, and
deposit and loan products and services. 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.
TREASURY / OTHER
This segment includes assets, liabilities, equity, revenue, and expense that are
not directly assigned or allocated to one of the lines of business. Since a
match-funded transfer pricing system is used to allocate interest income and
interest expense to other business segments, Treasury / Other results include
the net impact of any over or under allocations arising from centralized
management of interest rate risk including the net impact of derivatives used to
hedge interest rate sensitivity. Furthermore, this segment's results include the
net impact of administering Huntington's investment securities portfolio as part
of overall liquidity management, as well as the impact of mezzanine lending
activity conducted through Huntington's Capital Markets Group. Additionally,
amortization expense of intangible assets, the 2002 gain on sale of the Florida
operations, the 2002 restructuring charges, and other gains or losses not
allocated to other business segments are also a component.
Listed below is certain reported financial information reconciled to
Huntington's three and six month 2003 and 2002 operating results by line of
business.
15
16
NOTE 11 - DIVESTITURES
On July 25, 2003, Huntington sold four banking offices located in the
eastern panhandle of West Virginia. This sale included approximately $50 million
of loans and $130 million of deposits. Huntington expects to report a pre-tax
gain from this sale of between $12 million and $13 million in the third quarter
of 2003.
On July 2, 2002, Huntington also completed the sale of its Florida
insurance operations, The J. Rolfe Davis Insurance Agency, Inc., to members of
its management. Though the sale affected selected Non-interest income and
Non-interest expense categories, it had no material gain or impact to net
income.
On February 15, 2002, Huntington completed the sale of its Florida
operations to SunTrust Banks, Inc. Included in the sale were $4.8 billion of
deposits and other liabilities and $2.8 billion of loans and other assets.
Huntington received a deposit premium of 15%, or $711.9 million. The total net
pre-tax gain from the sale was $181.3 million and is reflected in Non-interest
income. The after-tax gain was $60.7 million, or $0.24 per share. Income taxes
related to this transaction were $120.7 million, an amount higher than the tax
impact at the statutory rate of 35% because most of the goodwill relating to the
Florida operations was non-deductible for tax purposes.
NOTE 12 - SEC INVESTIGATION
On June 26, 2003 Huntington announced that the Securities and Exchange
Commission (SEC) staff is conducting a formal investigation, and that Huntington
is cooperating fully with the investigation. The formal investigation began
following Huntington's announcement on April 16, 2003 that it intended to
restate its financial statements in order to reclassify its accounting for
automobile leases from the direct financing lease method to the operating lease
method. The investigation also follows allegations by a former Huntington
employee regarding certain aspects of Huntington's accounting and financial
reporting practices, including the recognition of automobile loan and lease
origination fees and costs, as well as certain year-end reserves. These
allegations were immediately reviewed with the Audit/Risk Committee, a Board
committee composed entirely of independent directors. The Audit/Risk committee
retained independent legal counsel who, in turn, retained independent
accountants to assist it in its investigation of the allegations. While the
investigation is ongoing, progress reports have been shared with the Audit/Risk
Committee and the SEC. The SEC investigation is ongoing and Huntington is
continuing to cooperate fully.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
INTRODUCTION
Huntington Bancshares Incorporated (Huntington) is a multi-state
diversified financial services 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
underwriting credit life and disability insurance, and selling other insurance
and financial products and services. Huntington's banking offices are located in
Ohio, Michigan, Indiana, Kentucky, and West Virginia. Selected financial
services are also conducted in other states including Arizona, Florida, Georgia,
Maryland, New Jersey, Pennsylvania, and Tennessee. Huntington also has a foreign
office in the Cayman Islands and a foreign office in Hong Kong. The Huntington
National Bank (the Bank) 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 document.
FORWARD-LOOKING STATEMENTS
This interim 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, 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 under the heading "Business Risks" included in Item 1 of
Huntington's amended 2002 Annual Report on Form 10-K/A filed on May 20, 2003
(amended Form 10-K/A) and other factors described from time to time in other
filings with the Securities and Exchange Commission.
Management encourages readers of this interim 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 does not update forward-looking statements to
reflect circumstances or events that occur after the date the forward-looking
statements were made or to reflect the occurrence of unanticipated events.
RESTATEMENT OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Huntington has voluntarily restated its prior period financial results
to reflect a series of actions related to the timing and recognition of
origination fees paid to automobile dealers, deferral of commissions paid to
originate deposits, mortgage origination fee income, expenses related to pension
settlements, and reserves related to the sale of an automobile debt cancellation
product. In addition, Huntington reclassified certain tax consulting expenses
from income tax expense to professional services.
Financial information included in this report for the three and six
months ended June 30, 2002, has also been restated. Net income was reduced by
$0.9 million for the three-month period and increased by $2.0 million, or $0.01
per common share, for the six-month period. The cumulative effect of this
restatement reduced total loans and leases by $24.0 million, other assets by
$14.2 million, other liabilities by $10.7 million, and retained earnings by
$27.5 million at June 30, 2002.
The results of this restatement are reflected in the unaudited
consolidated financial statements, notes to the unaudited consolidated financial
statements, and management's discussion and analysis for all current and prior
periods reported in this Form 10-Q. Note 3 in the notes to the unaudited
consolidated financial statements contains additional information regarding this
restatement.
18
CRITICAL ACCOUNTING POLICIES
Note 1 to the consolidated financial statements included in Huntington's
amended Form 10-K/A lists significant accounting policies used in the
development and presentation of its financial statements. This discussion and
analysis, the significant accounting policies, and other financial statement
disclosures identify and address key variables and other qualitative and
quantitative factors that are necessary for an understanding and evaluation of
the organization, its financial position, results of operations, and cash flows.
USE OF ESTIMATES
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 amended Form 10-K/A.
ADOPTION OF FINANCIAL INTERPRETATION NO. (FIN) 46 INVOLVING SPECIAL PURPOSE
ENTITIES (SPEs)
Huntington established two securitization trusts, or SPEs, in 2000.
These two trusts had total assets of approximately $1.1 billion at June 30,
2003. In the securitization transactions, indirect automobile loans that
Huntington originated were sold to these trusts. Under GAAP at June 30, 2003,
these trusts were not required to be consolidated in Huntington's financial
statements. As such, the loans and the debt within the trusts were not included
on Huntington's balance sheets at June 30. See Note 10 to the consolidated
financial statements in Huntington's amended Form 10-K/A for more information
regarding securitized loans.
In January 2003, the Financial Accounting Standards Board (FASB) issued
FIN 46, Consolidation of Variable Interest Entities. This Interpretation of
Accounting Research Bulletin No. 51 (ARB 51), Consolidated Financial Statements,
addresses consolidation by business enterprises where ownership interests in an
entity may vary over time or, in many cases, of special-purpose entities (SPEs).
To be consolidated for financial reporting, these entities must have certain
characteristics. ARB 51 requires that an enterprise's consolidated financial
statements include subsidiaries in which the enterprise has a controlling
financial interest. This Interpretation requires existing unconsolidated
variable interest entities to be consolidated by their primary beneficiaries if
the entities do not effectively disperse risks among parties involved. An
enterprise that holds significant variable interests in such an entity, but is
not the primary beneficiary, is required to disclose certain information
regarding its interests in that entity. This Interpretation applies in the first
fiscal year or interim period beginning after June 15, 2003, to variable
interest entities in which an enterprise holds an interest that it acquired
before February 1, 2003. It also applies immediately to variable interest
entities created after January 31, 2003, and to variable interest entities in
which an enterprise obtains an interest after that date. This Interpretation may
be applied (1) prospectively with a cumulative effect adjustment as of the date
on which it is first applied, or (2) by restating previously issued financial
statements for one or more years with a cumulative effect adjustment as of the
beginning of the first year restated.
Effective July 1, 2003, Huntington adopted FIN 46 resulting in the
consolidation of one of the securitization trusts formed in 2000. The
consolidation of that trust involved recognition of the trust's assets and
liabilities, elimination of the related retained interest and servicing asset,
recognition of other related assets, and establishment of a 1.01% allowance for
loan and lease losses. Reflecting these impacts, the adoption of FIN 46 will
result in a cumulative effect charge of approximately $11 million, or $0.05 per
share, in the third quarter, a reduction of the ALLL by approximately 3 basis
points, and a reduction in the tangible common equity ratio of approximately 30
basis points. Regulatory capital will have minimal impact since these assets are
currently reflected in risk-based assets.
DERIVATIVES AND OTHER OFF-BALANCE SHEET ARRANGEMENTS
Huntington uses a variety of derivatives, principally interest rate
swaps, in its asset and liability management activities to mitigate the risk of
adverse interest rate movements on either cash flows or market value of certain
assets and liabilities.
Like other financial organizations, Huntington uses 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 noncancelable leases for its facilities. Derivatives and other
off-balance sheet arrangements are discussed under the "Interest Rate Risk
Management" section of this interim report and in the notes to the unaudited
consolidated financial statements.
19
RELATED PARTY TRANSACTIONS
Various directors and executive officers of Huntington, and entities
affiliated with those directors and executive officers, are customers of
Huntington's subsidiaries. All transactions with Huntington's directors and
executive officers and their affiliates are conducted in the ordinary course of
business under normal credit terms, including interest rate and
collateralization, and do not represent more than the normal risk of collection.
A summary of the indebtedness of management can be found in Note 9 to
Huntington's amended Form 10-K/A. All other related party transactions,
including those reported in Huntington's 2003 Proxy Statement and transactions
subsequent to December 31, 2002, were considered immaterial to its financial
condition, results of operations, and cash flows.
SUMMARY DISCUSSION OF RESULTS
2003 Second Quarter versus 2002 Second Quarter
Huntington's second quarter 2003 earnings were $97.4 million, or $0.42
per common share, up 33% and 45%, respectively, from $73.0 million, or $0.29 per
common share in the year-ago quarter. This primarily reflected the benefit of a
13% increase in fully taxable equivalent net interest income and an 8% decline
in non-interest expense, partially offset by a 5% decline in non-interest
income. The higher percent change in per common share earnings reflected the
benefit of repurchased common shares. The return on average assets (ROA) and
return on average equity (ROE) were 1.39% and 17.5%, respectively, compared with
1.17% and 12.5% in the year-ago quarter.
Fully taxable equivalent net interest income increased $24.6 million, or
13%, reflecting a $4.0 billion, or 20%, increase in average earning assets,
partially offset by a 25 basis point, or an effective 6%, decline in the fully
taxable equivalent net interest margin to 3.69% from 3.94%. The decline in
non-interest expense of $25.6 million, or 8%, primarily reflected a $28.8
million, or 22%, decline in operating lease expense, and $5.3 million decrease
in restructuring charges, partially offset by a $7.2 million, or 7%, increase in
personnel costs. Non-interest income decreased $13.5 million, or 5%, primarily
due to a $43.8 million, or 26%, decline in operating lease income, partially
offset by a $21.2 million increase in other income, which included an $11.6
million gain from the sale of automobile loans.
2003 Second Quarter versus 2003 First Quarter
Compared with the first quarter 2003 earnings of $90.6 million, or $0.39
per common share, second quarter earnings and earnings per common share were up
7% and 8%, respectively. This increase primarily reflected the benefit of a 6%
decline in non-interest expense and 2% increase in non-interest income,
partially offset by a 34% increase in provision for loan and lease losses. Fully
taxable equivalent net interest income was up 1% between quarters. ROA and ROE
were 1.34% and 16.3%, respectively, in the first quarter 2003.
The $18.3 million, or 6%, decline in non-interest expense was driven
primarily by an $8.6 million, or 8%, decline in operating lease expense, a $7.7
million, or 6%, decline in personnel costs, and a $4.3 million decline in
restructuring charges. The $6.2 million, or 2%, increase in non-interest income
reflected the $3.3 million increase in gains from sales of automobile loans and
a $5.7 million increase in securities gains, partially offset by a $9.5 million,
or 7%, decline in operating lease income.
20
(1) Each of the quarters in 2002 and the first quarter in 2003 have been
restated. Please see note 3 to the unaudited consolidated financial
statements for further information.
(2) Represents the tax-exempt portion of net interest income increased by an
amount equivalent to taxes that would have been paid if this income had
been taxed at a 35% statutory tax rate.
(3) Non-interest expense less amortization of intangible assets divided by the
sum of fully taxable equivalent net interest income and non-interest income
excluding securities gains.
21
2003 First Six Months versus 2002 First Six Months
For the first six months of 2003, earnings were $188.0 million, or $0.81
per common share, up 11% and 19%, respectively, from $169.0 million, or $0.68
per common share, in the comparable year-ago period. This increase primarily
reflected the benefits of a 14% increase in fully taxable equivalent net
interest income, a 15% decline in non-interest expense, a 3% decline in
provision for loan and lease losses, and a lower effective tax rate, partially
offset by a 30% decline in non-interest income. The year-ago six-month period
included two significant items. The first consisted of a $181.3 million pre-tax
gain ($60.7 million after tax, or $0.24 per common share) from the sale of the
Florida banking operations reported in non-interest income. The second was $56.2
million ($36.5 million after tax, or $0.15 per common share) in restructuring
charges related to the strategic initiatives announced in July 2001 reported in
non-interest expense. The higher percent change in per common share earnings
reflected the benefit of repurchased shares. ROA and ROE were 1.37% and 16.9%,
respectively, up from 1.32% and 14.4%, in the year-ago six-month period.
The $53.7 million, or 14%, increase in fully taxable equivalent net
interest income reflected a $3.1 billion, or 15%, increase in average earnings
assets, partially offset by a 4 basis point, or an effective 1%, decline in the
fully taxable equivalent net interest margin to 3.75% from 3.79%. The $110.8
million, or 15%, decline in non-interest expense primarily reflected a $62.5
million decline in restructuring charges and a $58.0 million, or 21%, decline in
operating lease expense, partially offset by a $13.3 million, or 6%, increase in
personnel costs. Provision for loan and lease losses decreased $2.8 million, or
3%, and reflected a release of provision associated with the loans sold with
Florida banking operations in the prior year, partially offset by higher
provision expense due to loan growth and higher net charge-offs.
The reduction in tax expense reflects the decline in the effective tax
rate to 26.3% in the current six-month period, down from 47.1%, in the year-ago
six-month period. The higher effective tax rate in the year-ago period reflected
the fact that most of the goodwill relating to the sold Florida operations was
non-deductible for tax purposes.
RESULTS OF OPERATIONS
NET INTEREST INCOME
2003 Second Quarter versus 2002 Second Quarter
Compared with the year-ago quarter, fully taxable equivalent net
interest income increased $24.6 million, or 13%, reflecting the benefit of an
increase in average earning assets, partially offset by a 25 basis point, or an
effective 6%, decline in the net interest margin to 3.69% from 3.94%. The
decline in the fully taxable equivalent net interest margin was driven by a
number of factors including significant repayments and prepayments of higher
rate mortgages and mortgage backed securities, growth in lower rate but higher
quality automobile loans and direct financing leases, and the difficulty in
lowering deposit rates as fast as the decline in rates on loans and securities.
Average total earning assets increased $4.0 billion, or 20%, of which $0.8
billion related to higher securities and $3.2 billion related to higher average
loans and leases and mortgages held for sale.
Average securities increased $0.8 billion, or 29%, from the year-ago
quarter reflecting the investment of deposit inflows, proceeds from loan sales,
and pay downs of operating leases in excess of loan and lease originations.
Average mortgages held for sale increased $0.4 billion, more than twice the
level of a year earlier, due to high loan originations of mortgages reflecting
continued heavy refinancing activity.
Compared with the year-ago quarter, average loans and leases increased
$2.7 billion, or 16%. Average automobile loans and leases increased $1.4
billion, or 52%. This high growth rate was influenced by the significant growth
in direct financing automobile leases as this portfolio is relatively new and
consists only of leases originated after April 2002 with no meaningful
offsetting impact from maturing leases. Average automobile loans were up 10%. As
part of a plan to reduce loan concentration exposure to the automobile financing
business, $569 million of automobile loans were sold in the second quarter 2003,
following the sale of $558 million in the first quarter. This brought 2003
year-to-date sales to $1.1 billion. Each sale occurred at the end of their
respective quarter and, thus, did not have a material impact on average balances
for their respective quarters. However, the first quarter sale did have a
material impact on second quarter 2003 averages and comparisons to the year-ago
quarter. Excluding the impact of the first quarter sale, average automobile
loans in the second quarter 2003 were up 32% from the year-ago quarter.
Average residential mortgages increased $0.5 billion, or 36%, with
average home equity loans and lines up $0.4 billion, or 15%, reflecting the
impact low interest rates had on home borrowing and refinancing. Total average
commercial real estate loans increased $0.4 billion, or 11%. Average commercial
loans were essentially flat with the year-ago period. While small business
banking loans showed some growth, this was offset by declines in larger
commercial loans, including a reduction in exposure to shared national credits.
22
Compared with the year-ago quarter, average core deposits increased $0.7
billion, or 5%, including a $0.7 billion, or 20%, decline in retail CDs. Retail
CDs, which continued to be a relatively expensive source of funds, were
de-emphasized in the company's deposit generation strategies. Average core
deposits excluding retail CDs were up 13% from the year-ago quarter.
2003 Second Quarter versus 2003 First Quarter
Fully taxable equivalent net interest income in the second quarter 2003
increased $1.8 million, or 1%, from the first quarter, reflecting growth in
average earning assets substantially offset by a decline in the net interest
margin. The fully taxable equivalent net interest margin declined to 3.69% from
3.84%, down 15 basis points, or an effective 4%, driven by the same factors that
affected comparisons to the year-ago quarter, as noted above. Average total
earning assets increased $0.9 billion, or 4%, of which $0.4 billion related to
higher securities and $0.5 billion related to higher average loans and leases
and mortgages held for sale.
Average securities increased $0.4 billion, or 11%, from the first
quarter reflecting the investment of deposit inflows, proceeds from loan sales,
and pay downs of operating leases in excess of loan and lease originations.
Average mortgages held for sale increased $0.1 billion, or 31%, from the first
quarter due to high loan originations reflecting continued heavy refinancing
activity.
Average loans and leases increased $0.3 billion, or 2%, from the first
quarter, or 4% excluding the impact of automobile loan sales. Reflecting the
impact of the low interest rate environment, average residential mortgages grew
3% and average home equity loans and lines of credit increased 4%. Average
automobile loans and leases increased 1%, or 12% excluding the impact of the
first quarter sale of $558 million of automobile loans. Loans sold in the first
quarter impacted average loans and leases in that quarter by $459 million.
Year-to-date sales of automobile loans totaled $1.1 billion with such sales
reflecting a strategy to reduce loan concentration exposure to the automobile
financing business. Total average commercial real estate loans increased 3%. In
contrast, average commercial loans were essentially unchanged reflecting a 3%
growth in small business loans, offset by declines in larger commercial credits.
Total average core deposits in the second quarter 2003 increased $0.5
billion, or 3%, from the first quarter including a $0.2 billion, or 6%, decline
in retail CDs. Excluding retail CDs, average core deposits increased 5%.
Table 2 of this report reflects quarterly average balance sheets and
rates earned and paid on Huntington's interest-earning assets and
interest-bearing liabilities.
2003 First Six Months versus 2002 First Six Months
Net interest income on a fully taxable equivalent basis for the first
six months of 2003 increased $53.7 million, or 14%, from the comparable year-ago
period. This reflected 15% growth in average earnings assets, as the fully
taxable equivalent net interest margin declined slightly to 3.75% from 3.79%,
down 4 basis points, or an effective 1%. Average total earning assets increased
$3.1 billion, or 15%, of which $0.7 billion related to higher average
securities, $0.3 billion to higher average mortgages held for sale, and $2.2
billion related to higher average loans and leases.
The higher average balances in securities and mortgages held for sale
reflect the same factors influencing the year-over-year quarterly comparisons
discussed above.
Average loans and leases increased $2.2 billion, or 13%, from the
year-ago six-month period. This increase was driven primarily by a $1.4 billion,
or 50%, increase in average automobile loans and leases, impacted by the
significant growth in direct financing automobile leases given reclassification
of all April 2002 and prior originations as operating leases. Average automobile
loans increased 12%, but rose 25% excluding the impact of the loan sales.
Average residential mortgages were up $0.6 billion, or 45%, with average home
equity loans and lines of credit up $0.2 billion, or 8%. Average commercial real
estate loans were $0.3 million, or 7%, higher than in the year-ago period,
whereas average commercial loans were down $0.2 billion, or 4%, reflecting the
continued weak demand for commercial credits and planned decline in the shared
national credit portfolio, partially offset by growth in small business loans.
Total average core deposits for the first six months of 2003 were down
$298 million, or 2%, reflecting the impact of the 2002 first quarter sale of
$4.7 billion of deposits sold with the Florida banking operations. Excluding the
impact of these sold deposits, six-month 2003 average core deposits were up $833
million, or 6%, from the comparable year-ago period. Excluding retail CDs,
average core deposits increased 6%.
Table 3 of this report reflects year-to-date 2003 and 2002 average
balance sheets, related interest income and expense, and rates earned and paid
on Huntington's interest-earning assets and interest-bearing liabilities.
23
(1) Fully tax equivalent yields are calculated assuming a 35% tax rate.
(2) Individual loan components include applicable fees.
(3) Loan and deposit average rates include impact of applicable derivatives.
24
(1) Fully tax equivalent net interest income and yields are calculated assuming
a 35% tax rate.
(2) Individual loan components include applicable fees.
(3) Loan and deposit average rates include impact of applicable derivatives.
25
PROVISION FOR LOAN AND LEASE LOSSES
The provision for loan and lease losses is the expense necessary to
maintain the allowance for loan and lease losses (ALLL) at a level adequate to
absorb management's estimate of inherent losses in the total loan and lease
portfolio. Taken into consideration are such factors as current period net
charge-offs that are charged against the ALLL, 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, the anticipated
impact on credit quality of existing loans and leases, and other factors.
2003 Second Quarter versus 2002 Second Quarter
Provision for loan and lease losses in the second quarter was $49.2
million, down $0.7 million, or 1%, from the year-ago quarter. At June 30, 2003,
the allowance for loan and lease losses as a percent of period-end loans and
leases was 1.79%, down from 2.10% at the end of the year-ago quarter. The
decline in this ratio reflected a 40% decrease in non-performing assets between
the end of the year-ago quarter and June 30, 2003. In contrast, as a percent of
non-performing assets, the ALLL increased to 255% at June 30, 2003, from 158% at
June 30, 2002. (See Tables 10 and 11.)
2003 Second Quarter versus 2003 First Quarter
Provision for loan and lease losses in the second quarter was up $12.3
million, or 34%, from the first quarter due primarily to an $8.1 million
provision expense reflecting loan growth, and to a lesser degree higher net
charge-offs between periods. The June 30, 2003, ALLL as a percent of period-end
loans and leases was 1.79%, up slightly from 1.78% at March 31, 2003. The
allowance for loan and lease losses as a percent of non-performing assets
increased to 255% at June 30, 2003, from 239% at the end of the immediately
preceding quarter.
2003 First Six Months versus 2002 First Six Months
Provision for loan and lease losses for the first six months was $86.0
million, down $2.8 million, or 3%, reflecting a $6.1 million, or 8%, decline in
net charge-offs, partially offset by loan and lease growth.
NON-INTEREST INCOME
2003 Second Quarter versus 2002 Second Quarter
Non-interest income in the second quarter 2003 was $274.2 million, down
$13.5 million, or 5%, from $287.7 million in the year-ago quarter. This decline
was driven primarily by a $43.8 million, or 26%, decline in operating lease
income as this portfolio runs off due to the fact that all automobile leases
originated after April 2002 are direct financing leases. Unlike income on
operating leases, the income on direct financing leases is reflected in net
interest income. (See Operating Lease discussion.) Excluding operating lease
income of $124.2 million and $168.0 million from the current and year-ago
quarters, respectively, non-interest income was up $30.4 million, or 25%. (See
Table 4.)
Fee income categories that increased over this period included service
charges on deposit accounts, up $5.3 million, or 15%, due to higher NSF and
overdraft fees on retail accounts. Mortgage banking income increased $0.9
million, or 9%, reflecting higher origination-related fees due to the increased
volume of mortgage originations, partially offset by an acceleration in the
amortization of mortgage servicing rights (MSRs) and a $6.4 million MSR
impairment charge in the current quarter versus $0.9 million in the year-ago
quarter. The MSR impairment charge and acceleration in the amortization of MSRs
reflected high mortgage prepayment levels as the low interest rate environment
continued to produce high refinancing activity. At June 30, 2003, MSRs as a
percent of serviced mortgages were 0.72%, down from 1.00% at June 30, 2002. The
increase in the gains on sales and securitizations of loans includes $11.6
million million gain on the sale of automobile loans in the current quarter. The
$9.5 million increase in other income reflected a $4.4 million increase in
trading-related revenue, $4.1 million of higher fees from automobile lease
terminations, and a $3.2 million increase in the market value of certain equity
investments partially offset by other miscellaneous income categories. Other
service charge income increased $0.8 million, or 8%, reflecting higher
transaction-based product fees.
Fee income categories that decreased included brokerage and insurance
income, down $2.7 million, or 16%, primarily due to lower insurance income
associated with the sold J. Rolfe Davis Insurance Agency, Inc. Trust services
income was down $0.6 million, or 4%, due to a decline in average asset values.
Table 4 shows details of non-interest income for the three and six-month periods
ended June 30, 2003 and 2002:
26
2003 Second Quarter versus 2003 First Quarter
Non-interest income of $274.2 million in the second quarter was up $6.2
million, or 2%, from $268.0 million the first quarter, despite a $9.5 million
decline in operating lease income. Excluding operating lease income of $124.2
million from the current quarter and $133.8 million in the 2003 first quarter,
non-interest income was up $15.7 million, or 12%.
Income categories that increased included other income, up $10.1
million. This increase reflected higher fees from the termination of operating
lease assets, an increase in the market value of certain equity investments, as
well as higher letter of credit fees. The increase in the gains on sales and
securitizations of loans included $3.3 million higher gains from sales of
automobile loans offset by $0.6 million lower securitization gains. Securities
gains totaled $6.9 million, up $5.7 million from the first quarter. Service
charges on deposit accounts increased $1.0 million, or 3%, due to higher retail
fees. Other service charges and fees were up $1.0 million, or 10%, reflecting
higher transaction-based product fees from the seasonally weak first quarter.
Trust services increased $0.7 million, or 4%, due to higher institutional fees.
Partially offsetting these increases were declines in several fee income
categories, including brokerage and insurance income, down $1.3 million, or 8%,
due to an 18% decline in annuity sales, though mutual fund sales increased 45%.
Mortgage banking income declined $2.8 million, or 20%, from the first quarter
reflecting a $6.4 million impairment of MSR in the current quarter, compared
with no impairment in the first quarter 2003. Excluding the MSR impairment,
mortgage banking income increased $3.6 million, or 26%, reflecting a 34%
increase in closed loan production. At June 30, 2003, MSRs as a percent of
mortgages serviced for others were 0.72%, down from 0.80% at March 31, 2003.
2003 First Six Months versus 2002 First Six Months
Non-interest income for the first six months of 2003 was $542.2 million,
down $229.6 million, or 30%, from
27
$771.8 million in the comparable year-ago period. This decline reflected the
$181.3 million gain from the sale of the Florida banking operations in the
year-ago period, as well as an $86.0 million, or 25%, decline in operating lease
income as this portfolio runs off. (See Operating Lease discussion.) Excluding
the year-ago gain, as well as operating lease income of $258.0 million and
$344.0 million from the current and year-ago six-month periods, respectively,
non-interest income was up $37.7 million, or 15%.
Non-interest income categories contributing to the increase included
service charges on deposit accounts, up $6.4 million, or 9%; a $6.7 million
increase in securities gains; and a $11.0 million increase in other income. The
increase in other income was due to a $7.6 million increase in lease termination
fees, and a $7.5 million increase in capital markets-related income including
trading and sales activities, partially offset by a $3.1 million decrease in
standby letter of credit fees related to the implementation of FIN 45, as well
as lower other miscellaneous fees. Gains on sales and securitizations of loans
included $19.9 million in gains from the sale of automobile loans in the first
six months. Brokerage and insurance income was down $4.8 million, or 14%, and
trust services declined $1.3 million, or 4%, reflecting the same factors
influencing the declines between second quarters. Mortgage banking income
declined $3.6 million, or 13%, reflecting year-to-date MSR impairments totaling
$6.4 million in 2003 versus $1.1 million in the year-ago period.
NON-INTEREST EXPENSE
2003 Second Quarter versus 2002 Second Quarter
Non-interest expense in the second quarter 2003 was $306.0 million, down
$25.7 million, or 8%, from $331.7 million in the year-ago quarter. This decline
was driven primarily by a $28.8 million, or 22%, decline in operating lease
expense as this portfolio runs off. (See Operating Lease discussion). Excluding
operating lease expense of $102.9 million and $131.7 million from the current
and year-ago quarters, respectively, non-interest expense was up $3.1 million,
or 2%. (See Table 5).
This $3.1 million increase reflected a $7.2 million, or 7%, increase in
personnel costs with higher salaries, sales commissions, and benefit expenses
each contributing equally to the increase. Full-time equivalent staff at the end
of June 2003 was 8,093, down slightly from 8,174 at the end of the second
quarter last year. Professional services expense increased $2.0 million, or 26%,
primarily related to legal and audit expenses associated with the restatement
announced in May of this year and costs pertaining to the investigation by the
SEC. Also contributing to the increase were higher marketing expenses, up $1.2
million, or 17%.
These increases were partially offset by the benefit of a $5.3 million
release of restructuring reserves, of which $3.8 million related to reserves
established in 1998 and $1.5 million related to reserves established in 2001 and
2002. The 1998 reserve was established for, among other items, the exit of
underperforming product lines, including possible third-party claims related to
these exits. Management reviewed this reserve and determined that future claims
were unlikely or would be immaterial, and therefore, reduced the level of the
reserve through a credit, or reserve release, to the restructuring charge
expense category. As of June 30, 2003, Huntington has remaining reserves for
restructuring of $0.3 million related to the 1998 strategic initiative, and $9.1
million related to the 2001 strategic initiatives, respectively. Huntington
expects that this remaining reserve will be adequate to fund the remaining
estimated future cash outlays that are expected in the completion of the exit
activities contemplated by Huntington's 2001 strategic refocusing plan. Cost for
printing and supplies declined $1.4 million, or 39%, due largely to incentives
received from a new check-printing vendor that partially offset such costs in
the second quarter 2003.
Table 5 reflects details of non-interest expense for the three and six
months ended June 30, 2003 and 2002:
28
2003 Second Quarter versus 2003 First Quarter
Non-interest expense of $306.0 million in the current quarter was down
$18.3 million, or 6%, from $324.3 million the first quarter. This decline
reflected an $8.6 million, or 8%, decline in operating lease expense as the
operating lease portfolio runs off. (See Operating Lease discussion.) Excluding
operating lease expense of $102.9 million and $111.6 million from the current
and prior quarters, respectively, non-interest expense was down $9.6 million, or
5%.
Contributing to the $9.6 million decline were lower personnel costs,
down $7.7 million, or 6%, due to a combination of lower salaries, benefit, and
severance costs. Net occupancy expense decreased $1.2 million, or 7%, as the
first quarter results included significant seasonal costs, while printing and
supplies costs declined $1.4 million, or 39%. Partially offsetting these
declines were increases in a number of expense categories including a $3.5
million, or 20%, increase in other expenses spread across a number of
categories. Marketing expense increased $1.8 million, or 28%, with professional
services expense up $0.6 million, or 6%, primarily related to legal and audit
expenses associated with the restatement announced in May of this year and the
investigation by the SEC.
2003 First Six Months versus 2002 First Six Months
Non-interest expense for the first six months of 2003 was $630.4
million, down $110.8 million, or 15%, from $741.2 million in the comparable
year-ago period. Two items significantly affect this year-over-year comparison.
Changes in restructuring reserves for the six month 2003 period represented a
net credit, or release, to reserves of $6.3 million compared with $56.2 million
of charges in the year-ago period primarily related to the last significant
charges associated with the strategic initiatives announced in July 2001,
including the sale of the Florida banking operations. The second is a $58.0
million, or 21%, decline in operating lease expense as the portfolio of
operating lease assets runs off. (See Operating Lease discussion.) Excluding the
impact of restructuring charges and releases, as well as operating lease expense
of $214.5 million and $272.5 million from the current and year-ago six-month
periods, respectively, non-interest expense was
29
up $9.6 million, or 2%.
This $9.6 million increase reflected increases of $13.3 million, or 6%,
in personnel costs, and a $4.9 million, or 34%, increase in professional
services. Partially offsetting these increases were declines of $2.3 million, or
7%, in outside data processing and other services, and a $1.6 million, or 21%,
decline in printing and supply costs. These year-to-date changes reflect the
same factors influencing comparisons between second quarters. In addition, other
expenses declined $4.7 million, or 11%, reflecting lower state and local tax
expense and amortization of intangible assets.
OPERATING LEASE ASSETS
Operating lease assets represent automobile leases originated before May
2002. This operating lease portfolio will run-off over time since all automobile
lease originations since May 2002 have been recorded as direct finance 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. Average operating lease
assets in the second quarter 2003 were $1.8 billion, down 36% from the year-ago
quarter and 13% from the first quarter 2003.
Operating lease income, which totaled $124.2 million in the second
quarter 2003, represented 45% of non-interest income in that quarter. Operating
lease income was down $43.8 million, or 26%, from the year-ago quarter and $9.5
million, or 7%, from the first quarter 2003, reflecting declines in average
operating leases of 36% and 13%, respectively. 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 was down 25% and 8%, respectively, from the year-ago and first quarter.
Fees declined 70% and 12%, respectively, from the year-ago and prior quarters.
Recoveries from early terminations declined 31% from the year-ago quarter, but
were up 16% from the first quarter.
Operating lease expense totaled $102.9 million, down $28.8 million, or
22%, from the year-ago quarter and was down $8.6 million, or 8%, from the 2003
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 declined $0.2 million, or 2%, from the year-ago quarter, and
$0.8 million, or 6%, from the prior quarter.
For the first six months of 2003, operating lease income totaled $258.0
million, compared with $344.0 million for the same period last year. This
decline reflected 33% lower average operating lease balances for the comparable
periods. Net rental income and fees were down 23% and 79%, respectively, from a
year ago. Recoveries from early terminations declined nearly 35%. Operating
lease expense declined from $272.5 million for the six-month period last year to
$214.5 million. Losses on early terminations declined almost 16% from $28.3
million in the year-ago six month period to $23.9 million this year.
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.
Table 6 details operating lease assets performance for the three and six
months ended June 30, 2003 and 2002:
30
INCOME TAXES
The provision for income taxes in the second quarter 2003 was $37.2
million and represented an effective tax rate on income before taxes of 27.6%.
This was up $12.1 million from the year-ago quarter primarily due to higher
pre-tax income, as the effective tax rate in the year-ago quarter was lower at
25.6%. The effective tax rate in the first quarter 2003 was 24.9%. Each quarter,
taxes for the full year are re-estimated and year-to-date tax accrual
adjustments are made. A number of factors, such as year-to-date adjustments, can
result in fluctuations in quarterly effective tax rates.
31
For the first six months of 2003, the provision for income taxes was
$67.2 million and represented an effective tax rate on income before taxes of
26.3%. This was down $83.1 million from the comparable year-ago period in which
the effective tax rate was unusually high at 47.1%, reflecting the fact that
most of the goodwill relating to the Florida operations sold in the first
quarter of 2002 was non-deductible for tax purposes.
CREDIT RISK
Huntington's exposure to credit risk is managed through the use of
consistent underwriting standards that emphasize "in-market" lending while
avoiding excessive industry and other concentrations. The credit administration
function employs risk management techniques to ensure that loans and leases
adhere to corporate policy and problem loans and leases are promptly identified.
These procedures provide executive management with the information necessary to
implement policy adjustments where necessary, and to take corrective actions on
a proactive basis. Beginning in 2002, management increased its emphasis on
commercial lending to customers with existing or potential relationships within
Huntington's primary markets. As a result, outstanding shared national credits
were $832 million at June 30, 2003, down from $994 million at March 31, 2003,
and $998 million at the same period-end last year, and down from a peak of $1.5
billion at June 30, 2001.
In the first quarter of 2003, Huntington implemented a revised internal
risk grading methodology for commercial and commercial real estate credits.
Huntington's new methodology is a dual risk grading system that separately
measures the probability of default and loss in the event of default and
provides Huntington with more specificity in the risk assessment process.
LOAN AND LEASE COMPOSITION
Table 7 shows the period-end loan portfolio by loan type and business
segment:
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NET CHARGE-OFFS
Net charge-offs in the second quarter and first six months of 2003 were
$41.1 million and $73.9 million, respectively, and represented an annualized
0.85% and 0.77% of average loans and leases. For the same respective periods in
the prior year, net charge-offs were $37.0 million, or 0.90%, and $80.0 million,
or 0.94%. Table 8 reflects net charge-offs and annualized net charge-offs as a
percent of average loans and leases by type of loan:
Commercial charge-offs totaled $26.5 million, or an annualized 1.89% of
average commercial loans, for the second quarter 2003, up from $21.5 million, or
1.54%, in the year-ago quarter, and $14.9 million, or 1.06%, from the first
quarter 2003. The primary driver of this increase was the charge-off of one of
the second quarter's new non-performing assets, and which accounted for 45% of
total commercial charge-offs in the recent quarter. Total consumer net
charge-offs were $13.9 million, or an annualized 0.57% of average consumer
loans, during the second quarter 2003. This compares $13.4 million, or 0.72%, in
the second quarter of last year and $17.3 million, or 0.73%, in the first
quarter 2003. The recent decline from the first quarter was driven by a $3.1
million, or 29%, drop in automobile loan net charge-offs, from 1.38% to 1.06%.
Automobile direct financing lease net charge-offs totaled $1.4 million, or
0.43%, in the second quarter 2003 versus $0.5 million, or 1.20%, and $0.9
million, or 0.36%, for the second quarter 2002 and first quarter 2003,
respectively. As this lease portfolio is new and rapidly growing, management
anticipates that it may take a year or two to reach a mature, stable net
charge-off run rate, and therefore, the net charge-off ratio is likely to
increase over this period.
33
Management is not anticipating any significant increase in economic
activity in the second half of this year, nor any further weakening. Even though
economic uncertainty exists, management expects net charge-offs for the
full-year 2003 to be in the 0.70%-0.80% range.
NON-PERFORMING ASSETS
Non-performing assets (NPAs) consist of loans and leases that are no
longer accruing interest, loans and leases that have been renegotiated to below
market rates based upon financial difficulties of the borrower, and real estate
acquired through foreclosure. When interest accruals are suspended, accrued
interest income is reversed with current year accruals charged to earnings and
prior year amounts generally charged off as a credit loss. Commercial and
commercial real estate loans are generally placed on non-accrual status when
collection of principal or interest is in doubt or when the loan is 90 days past
due. Consumer loans and leases, excluding residential mortgages, are not placed
on non-accrual status but are charged off in accordance with regulatory
statutes, which is generally no more than 120 days past due. Residential
mortgages, while highly secured, are placed on non-accrual status within 180
days past due as to principal and 210 days past due as to interest, regardless
of security. A charge-off on a residential mortgage is recorded when the loan
has been foreclosed and the loan balance exceeds the fair value of the real
estate. The fair value of the collateral is then recorded as real estate owned.
When, in management's judgment, the borrower's ability to make periodic interest
and principal payments resumes and collectibility is no longer in doubt, the
loan is returned to accrual status.
Table 9 summarizes NPAs at the end of each of the recent five quarters
in addition to 90 day past due information:
Total NPAs were $133.7 million at June 30, 2003, down $89.5 million, or
40%, from the year-ago quarter, and down $7.0 million, or 5%, from March 31,
2003. The significant decrease in NPAs from the third to fourth quarter of 2002
was primarily due to the sale of NPAs that occurred in the fourth quarter 2002.
NPAs as a percent of total loans and leases and other real estate were 0.70% at
June 30, 2003, compared with 1.33% a year ago and 0.74% at March 31, 2003.
Loans and leases past due ninety days or more and still accruing
interest at the end of the second quarter of 2003 were $55.3 million versus
$47.7 million at the end of the same period a year ago. These past due loans and
leases represented 0.29% and 0.28% of total loans and leases at the end of the
second quarter of 2003 and 2002, respectively. At March 31, 2003, these loans
and leases amounted to $57.2 million and represented 0.30% of total loans and
leases. Table 10 reflects the change in NPAs for the recent five quarters:
34
New NPAs increased to $83.1 million during the most recent quarter from
$48.4 million in the first quarter 2003. Approximately 60% of the increase was
concentrated in three commercial credits, one in the manufacturing sector with
part of its business supporting automobile manufacturing, another in the
teleconferencing business, and the third in a combination of businesses
including marine shipping, mining, and raw materials. Of these credits, one was
charged off and another sold during the recent quarter. The level of payments
from the first to the second quarter 2003 increased, returning to levels
experienced in earlier quarters. This increase was spread over a number of
credits with no notable borrower concentrations. Despite the modest decline in
NPAs this recent quarter, management expects the level of NPAs to remain near
current levels throughout the second half of this year.
ALLOWANCE FOR LOAN AND LEASE LOSSES (ALLL)
The ALLL was $340.9 million at June 30, 2003, down from $351.7 million
at the end of the second quarter of 2002, but up slightly from the $337.0
million at March 31, 2003. The ALLL represented 1.79% of total loans and leases
at June 30, 2003, 2.10% at the end of the second quarter last year and 1.78% at
March 31, 2003. It is expected that the adoption of FIN 46 will decrease this
ratio by approximately 3 basis as the 1.01% reserve associated with the $1.0
billion of consolidated loans is less than the 1.79% ratio as of June 30, 2003.
The period-end ALLL was 255% of NPAs at June 30, 2003, compared with 158% a year
ago and 240% at March 31, 2003.
Table 11 reflects the activity in the ALLL for the recent five quarters.
The $3.5 million and $3.0 million allowance of sold loans in the second and
first quarters of 2003 related to the $569 million and $558 million of
automobile loans sold in the respective quarters. The $1.3 million of allowance
related to purchased loans in the third quarter of last year was attributed to
the LeaseNet acquisition.
35
Huntington allocates the ALLL to each loan and lease category based on
an expected loss ratio determined by continuous assessment of credit quality
reflecting portfolio risk characteristics and other relevant factors such as
historical performance, significant acquisitions and dispositions of loans, and
internal controls. For the commercial and commercial real estate credits,
expected loss factors are assigned by credit grade at the individual loan and
lease level at the time the loan or lease is originated, then subsequently
re-evaluated on a periodic basis. The aggregation of these factors represents
management's estimate of the inherent loss in the portfolio.
The portion of the allowance allocated to the more homogeneous consumer
loan and lease segments is determined by expected loss ratios based on the risk
characteristics of the various segments and giving consideration to existing
economic conditions and trends. Expected loss ratios incorporate factors such as
trends in past due amounts, recent loan and lease loss experience, and specific
risk characteristics at the loan and lease level. Actual loss ratios experienced
in the future could vary from those expected, as performance is a function of
factors unique to each customer as well as general economic conditions. While
amounts are allocated to various portfolio segments, the total ALLL, excluding
impairment reserves prescribed under provisions of Statement of Financial
Accounting Standard No. 114, is available to absorb losses from any segment of
the portfolio.
As of June 30, 2003, the entire ALLL is allocated to discrete loan
categories with the result being the elimination of any unallocated reserve.
INTEREST RATE RISK MANAGEMENT
Huntington seeks to minimize earnings volatility by managing the
sensitivity of net interest income and the fair value of its net assets to
changes in market interest rates. The Board of Directors and the Asset and
Liability Management Committee (ALCO) oversee various risks by establishing
broad policies and specific operating limits that govern a variety of risks
inherent in operations, including liquidity, counterparty credit risk,
settlement, and market risks.
Market risk is the potential for declines in the fair value of financial
instruments due to changes in interest rates, exchange rates, and equity prices.
Interest rate risk is Huntington's primary market risk. 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.
Interest rate risk management is a dynamic process that encompasses new
business flows onto the balance sheet, wholesale investment and funding, and the
changing market and business environment. Effective management of interest rate
risk begins with appropriately diversified investments and funding sources. To
accomplish overall balance sheet objectives, management regularly accesses
money, bond, futures, and options markets, as well as trading exchanges. In
addition, Huntington contracts with dealers in over-the-counter financial
instruments for interest rate swaps. ALCO regularly monitors position
concentrations and the level of interest rate sensitivity to ensure compliance
with approved risk tolerances. Interest rate risk modeling is performed monthly.
An income simulation model is used to measure the sensitivity of forecasted net
interest income to changes in market rates over a one-year horizon. Although
Bank Owned Life Insurance and automobile operating lease assets are classified
as non-interest earning assets, Huntington includes these portfolios in its
interest sensitivity analysis because both have attributes similar to fixed-rate
interest earning assets. Balance sheet growth assumptions are also considered in
the income simulation model.
The baseline scenario for the income simulation, with which all others
are compared, is based on market interest rates implied by the prevailing yield
curve. Alternative market rate scenarios are then employed to determine their
impact on the baseline scenario. These alternative market rate scenarios include
spot rates remaining unchanged for the entire measurement period, parallel rate
shifts on both a gradual and immediate basis, as well as movements in rates that
alter the shape of the yield curve. Scenarios are also developed to measure
basis risk, such as the impact of LIBOR-based rates rising or falling faster
than the prime rate.
Market value risk (referred to as Economic Value of Equity or EVE) is
measured using a static balance sheet. The models used for these measurements
take into account prepayment speeds on mortgage loans, mortgage-backed
securities, and consumer installment loans, as well as cash flows of other loans
and deposits. Moreover, the models incorporate the effects of embedded options,
such as interest rate caps, floors, and call options, and account for changes in
relationships among interest rates.
When evaluating short-term interest rate risk exposure, management uses,
for its primary measurement, scenarios that model parallel shifts in the yield
curve resulting in a gradual 200 basis point increase/decrease in rates over the
next twelve-month period. However, at December 31, 2002, only the 200 basis
point increasing parallel shift in the yield curve was reported because a 200
basis point decrease in the interest rate curve was not feasible given the
overall low level of interest rates. At June 30, 2003, that scenario modeled net
interest income 0.8% lower than the internal forecast of net
36
interest income over the same time period using the current level of forward
rates. This was relatively unchanged from the negative impact to net interest
income generated by the same 200 basis point scenario at the end of 2002.
Management believes further declines in market rates would put modest downward
pressure on net interest income, resulting from the implicit pricing floors in
non-maturity deposits.
The net interest margin has been adversely impacted in recent months by:
(1) fixed-rate consumer loan repayments being reinvested at lower market rates;
(2) high repayments and prepayments of residential mortgage loans and
mortgage-backed securities; (3) the implicit floors in retail deposits as rates
declined to historically low levels; (4) the rapid growth of lower-yielding
residential adjustable-rate mortgage loans retained on the balance sheet; (5)
the lower yield on the higher quality automobile loan originations; and (6) the
flattening of the yield curve. The net interest margin will continue to be
adversely affected by some of these factors over the next few quarters.
The primary measurement for EVE risk assumes an immediate and parallel
increase in rates of 200 basis points. At June 30, 2003, the model indicated
that such an increase in rates would be expected to reduce the EVE by 1.4%
compared with an estimated negative impact of 3.8% at December 31, 2002.
These models are a useful but simplified representation of Huntington's
underlying interest rate risk profile. Simulations reflect choices of
statistical techniques, functional forms, model parameters, and numerous other
assumptions. Nonetheless, experience has demonstrated and management believes
that these models provide reliable guidance for measuring and managing interest
rate sensitivity.
37
LIQUIDITY
Effectively managing liquidity involves meeting the cash flow
requirements of depositors and borrowers, as well as satisfying the operating
cash needs of the organization to fund corporate expansion and other activities.
ALCO establishes guidelines and regularly monitors the overall liquidity
position of the business and ensures that various alternative strategies exist
to cover unanticipated events. Furthermore, ALCO policies and/or guidelines
ensure that wholesale funding sources are diversified in order to avoid
concentration in any one market source. Management believes sufficient liquidity
was available at the end of the recent quarter to meet estimated funding needs
of the Bank and parent company.
Deposits are Huntington's primary source of funding, and represent 65%
of total assets of which 91% were provided by the Regional Banking segment.
Table 12 details the types and sources of deposits by business segment at June
30, 2003, and compares these balances by type and source to balances at December
31, 2002 and June 30, 2002:
Core deposits, which include non-interest bearing and interest bearing
demand deposits, savings accounts, and other domestic time deposits, including
certificates of deposit under $100,000 and IRAs, satisfy 86.7% of Huntington's
funding needs. Sources of wholesale funding include Federal funds purchased,
securities sold under repurchase agreement, brokered CDs, and medium- and
long-term debt. Wholesale funding activities are governed by the Bank's ALCO,
which establishes policies and guidelines to diversify funding sources and avoid
borrowing concentrations from any one market source.
Other sources of liquidity include the sale or maturity of investment
securities, the sale or securitization of loans, collateralized borrowings such
as Federal Home Loan Bank advances, and the issuance of common and preferred
securities in the capital markets. Huntington also has available a $6.0 billion
domestic bank note program through its bank subsidiary, Huntington National
Bank, of which $4.9 billion was available at June 30, 2003. In addition, the
Bank shares a $2.0 billion Euronote program with the parent company, of which
$1.4 billion was available on June 30, 2003. In addition, the parent company has
$295 million availability under a $750 million medium term note program as of
the same date.
38
CAPITAL
Capital is managed at each legal subsidiary based upon the respective
risks and growth opportunities, as well as regulatory requirements. Huntington
places significant emphasis on the maintenance of strong capital, 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 returns
to shareholders.
Shareholder's equity increased $47 million for the recent quarter and
$12 million during the first six months of 2003 and $58 million from June 30,
2002. The increase was less for the six-month period in 2003 primarily due to
the repurchase of 4.3 million common shares at a value of $81.1 million in the
2003 first quarter. In February 2002, the Board of Directors authorized a common
share repurchase program for up to 22 million common shares and canceled the
previously existing authorization. Under this authorization, a total of 19.4
million common shares were repurchased: 19.2 million in 2002, including 8.8
million common shares purchased in the first six months of 2002, and 0.2 million
in the 2003 first quarter. In mid-January 2003, the Board of Directors
authorized a new common share repurchase program, canceling the 2.6 million
common shares remaining under the February 2002 authorization, and approved a
new common share repurchase authorization for up to 8.0 million common shares.
Under this authorization, 4.1 million common shares were repurchased in the 2003
first quarter, leaving 3.9 million common shares remaining for repurchase at
June 30, 2003.
Average equity to average assets in the second quarter of 2003 was 7.96%
versus 9.42% for the same period last year. Tangible period-end equity to
period-end assets, which excludes intangible assets, was 7.31% at the end of
June 2003, down from 8.42% a year earlier. The high tangible equity to asset
ratio in the year-ago quarter reflected excess capital generated from the sale
of the Florida operations in the first quarter 2002. Management has a
longer-term targeted tangible equity to asset ratio of 7.00%, given the current
asset mix and risk profile.
Risk-based capital guidelines established by the Federal Reserve Board
set minimum capital requirements and require institutions to calculate
risk-based capital ratios by assigning risk weightings to assets and off-balance
sheet items, such as interest rate swaps, loan commitments, and securitizations.
These guidelines further define "well-capitalized" levels for Tier 1, total
capital, and leverage ratio purposes at 6%, 10%, and 5%, respectively.
Huntington's Tier 1 risk-based capital ratio, total risk-based capital ratio,
leverage ratio, risk-adjusted assets, and its tangible equity to assets ratio
for the recent five quarters are shown in Table 13:
As Huntington is supervised and regulated by the Federal Reserve, The
Huntington National Bank, Huntington's bank subsidiary, is supervised and
regulated by the Office of the Comptroller of the Currency, which establishes
similar regulatory capital guidelines for banks. The Bank also had regulatory
capital ratios in excess of the levels established for well-capitalized
institutions at June 30, 2003.
39
Table 14 details the cash dividends that were declared in the first
quarter 2003 and four prior quarters along with common stock prices (based on
NASDAQ intra-day and closing stock price quotes):
In July 2003, the board of directors declared a dividend of $0.175 per
common share for the third quarter 2003, an increase of 9.4% over the previous
quarterly dividend. The dividend is payable October 1, 2003, to shareholders of
record on September 19, 2003. Management has increased its dividend payout
target range to 40%-45% of earnings, up from the previous target range of
35%-45%.
LINES OF BUSINESS DISCUSSION
Below is a brief description of each line of business and a discussion
of business segment results for the three and six months ended June 30, 2003 and
2002. Regional Banking, Dealer Sales, and the Private Financial Group are the
major business lines. The fourth segment includes the impact of the Treasury
function and other unallocated assets, liabilities, revenue, and expense.
For analytical purposes in understanding performance trends, strategic
decision making, determining incentive compensation, and evaluating line of
business performance, chief decision-makers review and analyze certain data on
an "operating basis", which excludes the impact of restructuring charges and
releases and other items, as well as the results of operations from the Florida
banking and insurance operations sold in 2002. Since the items excluded are
associated with exited businesses and/or restructurings that have been completed
and no longer contribute to current or future period performance, management
believes their exclusion for analytical purposes provides a clearer picture of
underlying performance trends, as well as progress made in improving the
company's financial performance.
REGIONAL BANKING
Regional Banking provides products and services to retail, business
banking, and commercial customers. This segment's products include home equity
loans, first mortgage loans, direct installment loans, business loans, personal
and business deposit products, as well as sales of investment and insurance
services. These products and services are offered in six operating regions
within the five states of Ohio, Michigan, Indiana, West Virginia, and Kentucky
through Huntington's traditional banking network, Direct Bank--Huntington's
customer service center, and Web Bank at www.huntington.com. Regional Banking
also represents middle-market and large commercial banking relationships which
use a variety of banking products and services including, but not limited to,
commercial loans, commercial real estate loans, international trade, and cash
management.
40
Regional Banking's operating income was $24.3 million for the second
quarter 2003, an increase of 4% from $23.4 million for the same period a year
ago. For the six months ended June 30, 2003 and 2002, operating income was $58.3
million and $63.2 million, respectively.
Net interest income in the second quarter 2003 was up $5.9 million, or
4%, over the prior-year quarter. The increase reflected a 7% increase in average
loans and a 4% increase in average deposits. The increase was largely attributed
to increased mortgage loan balances, which reflected robust refinancing
activity. The net interest income on other loan and deposit growth was largely
offset by continued rate declines and the resulting repricing impact of loans
and deposits. Further margin compression resulted from the lower interest rate
environment and the inability to pass along lower rates to deposit customers.
Total average loans for the 2003 second quarter increased 7% to $13.0
billion from $12.2 billion in the year-ago quarter. Consumer loans grew 16% in
the comparable periods, most notably in home equity loans and lines, as well as
residential mortgage loans, which were up 14% and 28%, respectively. Business
banking loans, which is a continued strategic focus of this segment, grew 6%.
Average total deposits for the second quarter 2003 were up $635 million, or 4%,
from the same period a year ago. This increase reflected a 12% increase in
commercial demand deposits. Retail CDs, which continue to be a relatively
expensive source of funds, were de-emphasized in the company's deposit
generation strategies. Excluding retail CDs, this segment's average core
deposits increased 14%.
The provision for loan losses for the second quarter 2003 increased $3.7
million, or 10%, over the same quarter last year. This increase was largely
attributed to loan growth. Net charge-offs were $31.5 million, or an annualized
0.97% of average total loans and leases, for the three months ended June 30,
2003, compared to $32.5 million, or 1.07%, for the prior year quarter.
Commercial and commercial real estate net charge-offs declined $1.1 million
along with declines in net charge-offs for residential mortgage loans and other
consumer loans of $0.3 million and $0.4 million, respectively, for the
comparable periods, while net charge-offs for home equity loan increased $0.8
million.
Non-interest income for the second quarter 2003 was up $9.1 million, or
14%, from the year-ago quarter. Increased fee based revenue was driven by
deposit service charges, electronic banking, and mortgage banking revenue,
despite $6.4 million of mortgage servicing rights impairment recognized in the
second quarter of 2003, versus $1.1 million in the year-ago quarter. Standby
letters of credit income was down, due to the January 1, 2003 adoption of FASB
Interpretation No. 45 (see Note 2 to Huntington's unaudited consolidated
financial statements). Revenue generated from sales referrals from investment in
insurance products is included in Regional Banking's non-interest income as fee
sharing. Second quarter referrals generated $4.3 million of higher fee sharing
revenue versus the second quarter of last year.
Non-interest expense for the 2003 second quarter was $150.1 million, up
$10.0 million, or 7%, from the second quarter of 2002. The increase is due
primarily to personnel, occupancy and equipment expense. The increase in
salaries and benefits is reflective of investment in our management team and
volume related increases in performance based incentive compensation. Partially
offsetting these increases were decreases in printing and supplies, charge card
processing, and lower operating losses.
Regional Banking contributed 47% and 26% of total revenues and total
operating income, respectively, in the second quarter of 2003, and represented
52% of total assets and 91% of total deposits at June 30, 2003.
DEALER SALES
Dealer Sales 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 automobile under long-term operating and direct financing leases,
finances the dealership's inventory of automobiles, and provides other banking
services to the automotive dealerships and their owners.
41
Dealer Sales operating income was $19.7 million in the second quarter
2003, up from $10.0 million for the year-ago quarter. For the six months,
operating income was $37.6 million for 2003, up from $12.3 million for 2002.
Dealer Sales financial results are significantly impacted by changes
made in regard to accounting for automobile leases. As previously noted, leases
originated before May 2002 are accounted for as operating leases, and leases
originated afterwards accounted for as direct financing leases. Therefore, for
automobile leases originated before May 2002, the related financial results are
reported as non-interest income and non-interest expense with the cost of
funding these leases is included in interest expense. Such non-interest income,
non-interest expense, and interest expense will continue to trend lower in
subsequent periods since as this portfolio continues to run off. For leases
originated after April 2002, revenue is reported in interest income and a
provision for loan and lease losses is recorded in order to maintain an
appropriate level of reserve for loan and lease losses. As a result, net
interest income and the provision for loan and lease losses for the Dealer Sales
line of business should trend higher in future periods.
Net interest income was $21.0 million in the recent quarter, an increase
of $16.8 million from $4.2 million in the second quarter of 2002. This increase
reflected growth in average loan and direct financing lease balances from $3.4
billion in 2002 to $5.0 billion in 2003. This change in average balances was due
primarily to direct financing leases, which accounted for $1.2 billion of the
increase. The margin was also reduced by a $10.0 million charge to interest
expense associated with unwinding funding related to the loans sold in the
second quarter and $6.0 million related to loans sold in the first quarter.
The provision for loan and lease losses of $9.2 million for the second
quarter 2003 decreased $1.5 million from $10.7 million for the same period last
year. Net charge-offs totaled $9.1 million for the recent three months, or an
annualized 0.73% of average loans and direct finance leases, compared to $8.7
million, or 1.03%, during the year-ago quarter. This improvement continued to
reflect stronger underwriting practices for automobile loan and lease
originations.
Total non-interest income declined $31.9 million to $144.0 million for
the second quarter 2003 from $175.9 for the same period last year. This
reflected a $44.3 million decline in operating lease income from the second
quarter 2002 compared with the current year's second quarter, partially offset
by a gain of $11.6 million on the sale of $569 million of automobile loans in
the second quarter of 2003. Excluding operating lease income in the second
quarter of 2003 and 2002 of $123.7 million and $168.0 million, respectively, as
well as the $11.6 million gain on sale of automobile loans in the 2003 second
quarter, noninterest income was up $0.9 million, or 11%.
A decline in operating lease expense of $28.3 million in a
year-over-year comparison for the second quarter drove non-interest expense down
to $125.6 million for the second quarter 2003 from $153.9 million for the year
ago quarter. Excluding operating lease expense of $102.9 million in the 2003
second quarter and $131.7 million in the year-ago quarter, non-interest expense
was up $0.4 million, or 2%.
Dealer Sales contributed 34% of total second quarter 2003 revenues, 21%
of total operating income in the second quarter of 2003, and represented 24% of
total assets at June 30, 2003.
42
PRIVATE FINANCIAL GROUP
The Private Financial Group provides products and services designed to
meet the needs of Huntington's higher wealth customers. Revenue is derived
through the sale of personal trust, asset management, investment advisory,
brokerage, insurance, and deposit and loan products and services. 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.
Operating income in the second quarter 2003 was $7.9 million, compared
with $7.8 million for the second quarter 2002 as improvement in net interest
income and provision for loan losses were offset by lower non-interest income
(net of fee sharing to Regional Banking) and higher non-interest expense. On a
year-to-date basis, operating income was $13.3 million for 2003, up slightly
from $12.6 million in the same period of 2002.
Net interest income for the 2003 second quarter increased $0.9 million,
or 10%, from the year-ago quarter as average loan balances increased 35% to $1.2
billion and average deposit balances increased 23% to $974 million. Most of the
loan growth occurred in personal credit lines and residential mortgage loans
largely due to the favorable mortgage rate environment and refinancing activity.
A majority of the deposit growth occurred in the personal management accounts,
which resulted from a combination of new business and a customer shift in sweep
options from the Huntington Funds money market funds to money market deposit
accounts. The significant balance growth more than offset margin compression
that was caused by a loan product mix shift to lower-yielding products and
deposit rates that did not decrease as much as market rates.
Provision for loan and lease losses for the recent three months
decreased $0.9 million from the year-ago quarter due to a combination of lower
charge-offs and reduced loan provision resulting from the impact of reduced
non-performing assets from the first quarter 2003. Net charge-offs were $0.4
million for the second quarter 2003, or an annualized 0.15% of average total
loans and leases, compared with $1.1 million, or 0.51%, for the same period a
year ago.
Non-interest income decreased $0.8 million, or 3%. However, excluding
fee income shared with Regional Banking of $3.5 million in the 2003 second
quarter, and $2.5 million in the year-ago quarter, non-interest income increased
$0.2 million, or 1% from the year-ago quarter. This increase reflected higher
insurance income and other income partially offset by a decrease in trust and
brokerage revenue. Insurance revenue increased $0.7 million, or 28%, mainly from
an increase in title insurance revenue that was reflective of increased mortgage
loan refinancing. Trust income decreased $0.7 million, or 4%, mainly due to a
market-related decline in average asset values in two product areas that are
mostly market-rate sensitive: personal trust and Huntington Funds. Brokerage
revenue decreased $0.4 million, or 4%, primarily from a decline in mutual fund
revenue that was also reflective of the more bearish market environment.
Although the sales volume from mutual fund trades actually increased from the
year-ago quarter, revenue decreased because much of the increased volume
resulted from several large multi-million dollar trades that generated 12b-1
fees and no upfront revenue. Revenue from annuities also declined due to
decreased sales, but that was offset by revenue from the sale of the new wealth
transfer insurance product. Additional fee sharing income of $1.0 million was
shared out to Regional Banking primarily due to a change in methodology that
equates to approximately 0.75% of total mutual fund and annuity sales generated
through the banking offices.
Non-interest expense for the 2003 second quarter increased $0.8 million,
or 3%, from the year-ago quarter.
Private Financial Group contributed 8% of both total revenues and total
operating income in the second quarter of 2003, and represented 5% and 6% of
total assets and total deposits at June 30, 2003, respectively.
43
TREASURY / OTHER
The Treasury / Other segment includes assets, liabilities, equity,
revenue, and expense not directly assigned or allocated to one of the lines of
business. Since a match-funded transfer pricing system is used to allocate
interest income and interest expense to other business segments, Treasury /
Other results include the net impact of any over or under allocations arising
from centralized management of interest rate risk including the net impact of
derivatives used to hedge interest rate sensitivity. Furthermore, this segment's
results include the net impact of administering Huntington's investment
securities portfolio as part of overall liquidity management, as well as the
impact of mezzanine lending activity conducted through Huntington's Capital
Markets Group. Additionally, amortization expense of intangible assets and gains
or losses not allocated to other business segments are also a component.
Treasury / Other's operating income was $42.0 million and $74.6 million
in the second quarter and first half of 2003, respectively, up from last year's
respective operating income of $31.2 million and $58.3 million. Net interest
income for the recent three months was flat compared to the same period last
year despite transfer pricing charges made to the Dealer Sales line of business
for the early termination of funding related to the aforementioned June and
March 2003 sales of automobile loans.
Provision for loan and lease loss activity is related to the Capital
Markets Group, which provides mezzanine loans to customers. This particular
group manages certain loans, which require a level of ALLL that, in management's
judgment, is sufficient to cover losses inherent in the portfolio.
Non-interest income for 2003 second quarter was $26.7 million compared
with $13.9 million for the same period a year ago. Higher securities gains and
income from trading activities were the primary drivers for this increase.
Non-interest expense for the recent quarter was down $0.9 million from the
second quarter last year. This decline reflected higher allocated expenses to
other lines of business due to methodology changes.
Income tax expense for each of the other business segments is calculated
at a statutory 35% tax rate. However, Huntington's overall effective tax rate
was lower and, as a result, Treasury / Other reflected the reconciling items to
the statutory tax rate in its income taxes.
44
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosures for the current period are found
beginning on page 36 of this report, which includes changes in market risk
exposures from disclosures presented in Huntington's amended Form 10-K/A.
ITEM 4. CONTROLS AND PROCEDURES
Huntington carried out an evaluation, under the supervision and with the
participation of its management, including the Chief Executive Officer (CEO)
along with the Chief Financial Officer (CFO), of the effectiveness of its
disclosure controls and procedures as of June 30, 2003, pursuant to Exchange Act
Rule 13a-15(b). Based upon that evaluation, the CEO along with the CFO concluded
that Huntington's disclosure controls and procedures are effective in timely
alerting the CEO and CFO to material information relating to Huntington
(including its consolidated subsidiaries) required to be included in its
periodic SEC filings.
There were no changes in the second quarter to Huntington's internal control
over financial reporting that have materially affected, or are reasonably likely
to materially affect, Huntington's internal control over financial reporting.
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Huntington Bancshares Incorporated held its annual meeting of
shareholders on April 24, 2003. At that meeting, shareholders approved
the following management proposals:
45
ITEM 5. OTHER INFORMATION
It is expected that the following information will be included in the second
amendment to the 2002 Annual Report on Form 10-K/A and/or the amended 2003 First
Quarter Form 10-Q/A, when filed:
A. Impact of Restatement on Results of Operations and Financial Condition.
Huntington's restated results of operations and financial condition included the
following:
- - Huntington previously amortized the loan referral fees paid to automobile
dealers (dealer premium) on a straight-line basis. As a result of the
restatement, Huntington is now amortizing these fees to interest income
using methods that closely approximate the results under the interest
method. The impact of the restatement reduced the amount of dealer premium
included in automobile loans and leases, reduced interest income on
indirect loans and leases, and increased the other non-interest income.
- - Huntington previously deferred sales commissions paid to employees for the
origination of deposits and amortized these payments to interest expense
over the expected life of the deposit. In the restatement, Huntington is
recognizing the expense on these sales commissions when the deposits were
originated and commissions were earned. The impact of the restatement
decreased the interest expense on deposits, increased service charges on
deposit accounts, and increased personnel costs.
- - Huntington offers its customers the ability to forego the payment of
origination fees at inception of a mortgage loan in exchange for a higher
interest rate over the life of the loan. Huntington had previously recorded
origination fees on such loans held for investment at inception. A loan
premium was recognized and amortized as a reduction of interest income on
mortgage loans held for investment. The impact of the restatement reversed
the loan premiums that were recognized as mortgage banking income and
increased the interest income recognized on mortgage loans held for
investment.
- - Prior to 2002, Huntington recognized in the year incurred, the expense or
gains for pension settlements, which are actuarially determined expenses or
gains related to
lump-sum benefit payments paid to individuals who voluntarily or
involuntarily retire earlier than their expected retirement date or to
individuals who voluntarily or involuntarily separate from Huntington. The
expense for 2002 for pension settlements was deferred to be recognized over
a subsequent eight-year period. As part of the restatement, Huntington
recognized this expense consistent with years prior to 2002, which
increased other liabilities and increased personnel costs in the fourth
quarter of 2002.
- - Huntington previously recorded revenue from the sale of a contingent
automobile debt cancellation product by allocating a fixed portion of the
proceeds from each sale to revenue and reserves resulting in an incorrect
reserve balance. As part of the restatement, increased to cover expected
claim losses on the products purchased by customers, and, accordingly,
other liabilities and increased other non-interest expenses were increased.
- - Huntington previously recorded tax consulting expenses as a component of
income tax expense. The impact of the restatement reclassified those
expenses to professional services and had no impact on net income. Tax
consulting expense was $3.0 million for the first three months of 2003,
$7.3 million in 2002, $9.0 million in 2001, $1.9 million in 2000. No tax
consulting expenses were recorded as a component of income tax expense
prior to 2000.
The following table summarizes the impact of the restatement on prior periods:
B. Additional Disclosures Having No Financial Impact on Previously Reported
Results.
2002 Fourth Quarter Items:
Non-interest expense in the 2002 fourth quarter included the following:
- - Reserves of $7.2 million established in 1998 and 2001 were released in 2002
based on management's assessment of future claims on these reserves. The
release of 1998 reserves consisted of a $5.0 million legal settlement
received by Huntington in December 2002 and credited back to the 1998
reserves when it was received. Additionally, $2.2 million of reserves
established in 2001 were released. At December 31, 2002, Huntington had
$4.1 million remaining in reserves established in 1998 for the exit of
under performing business units and $14.4 million remaining in
restructuring reserves established in 2001. Also, at December 31, 2002,
Huntington had a contingency reserve related to its August 2002
restructuring of its interest in Huntington Merchant Services, L.L.C.
47
lump-sum benefit payments paid to individuals who voluntarily or
involuntarily retire earlier than their expected retirement date or to
individuals who voluntarily or involuntarily separate from Huntington. The
expense for 2002 for pension settlements was deferred to be recognized over
a subsequent eight-year period. As part of the restatement, Huntington
recognized this expense consistent with years prior to 2002, which
increased other liabilities and increased personnel costs in the fourth
quarter of 2002.
- - Huntington previously recorded revenue from the sale of a contingent
automobile debt cancellation product by allocating a fixed portion of the
proceeds from each sale to revenue and reserves resulting in an incorrect
reserve balance. As part of the restatement, increased to cover expected
claim losses on the products purchased by customers, and, accordingly,
other liabilities and increased other non-interest expenses were increased.
- - Huntington previously recorded tax consulting expenses as a component of
income tax expense. The impact of the restatement reclassified those
expenses to professional services and had no impact on net income. Tax
consulting expense was $3.0 million for the first three months of 2003,
$7.3 million in 2002, $9.0 million in 2001, $1.9 million in 2000. No tax
consulting expenses were recorded as a component of income tax expense
prior to 2000.
The following table summarizes the impact of the restatement on prior periods:
B. Additional Disclosures Having No Financial Impact on Previously Reported
Results.
2002 Fourth Quarter Items:
Non-interest expense in the 2002 fourth quarter included the following:
- - Reserves of $7.2 million established in 1998 and 2001 were released in 2002
based on management's assessment of future claims on these reserves. The
release of 1998 reserves consisted of a $5.0 million legal settlement
received by Huntington in December 2002 and credited back to the 1998
reserves when it was received. Additionally, $2.2 million of reserves
established in 2001 were released. At December 31, 2002, Huntington had
$4.1 million remaining in reserves established in 1998 for the exit of
under performing business units and $14.4 million remaining in
restructuring reserves established in 2001. Also, at December 31, 2002,
Huntington had a contingency reserve related to its August 2002
restructuring of its interest in Huntington Merchant Services, L.L.C.
- - Benefit costs were increased by year-end accruals related to medical,
long-term disability, and pension expenses, which aggregated $5.7 million.
- - Personnel expense reflected a credit of $1.5 million in gains related to
stock received from the demutualization of certain insurance companies
where Huntington owned related insurance policies.
- - Occupancy expense included a $1.5 million reversal of an excess accrual for
real estate taxes.
- - Year-end Adjustments to accruals reduced total non-interest expense by
$0.7 million related to litigation, marketing, and charitable
contributions.
- - A recovery of previous trust losses totaled $0.8 million.
- - A legal settlement of $0.7 million related to amounts received or to be
received from a joint venture in which Huntington was a participant.
- - Impairment of an investment in an unconsolidated subsidiary totaled $3.9
million.
- - Huntington recorded a minimum pension liability associated with its
Supplement Income Retirement plan and various other benefit plans based on
its actuarial valuation dated September 30, 2002. The minimum pension
liability was recognized because the plan's accumulated benefit obligation
exceeded the fair value of its assets. A pension asset of $1.4 million was
recorded equal to the plan's unrecognized prior service cost. The amount of
the minimum pension liability that exceeded the pension asset, which
represented a net loss not yet recognized as a net period pension cost,
amounted to $0.2 million and was recorded as a reduction of equity, net of
applicable taxes, as a separate component of accumulated other
comprehensive income.
2003 First Quarter Item:
- - Huntington has purchased insurance to cover the difference between the
recorded residual value of automobiles leased to customers and the fair
value at the end of the lease term, as evidenced by Black Book valuation.
This insurance does not cover residual losses below Black Book valuation,
which may arise when the automobile has excess wear and tear and/or excess
mileage, not reimbursed by the lessee. Huntington maintains a reserve to
cover such losses on direct financing leases based on quarterly evaluations
of several factors, including vehicle type, lease terms, used automobile
market conditions, new product offerings, expected leased vehicle return
rates, and historical experience. In the first quarter of 2003, Huntington
changed its methodology for calculating the appropriate reserve level. The
revised methodology estimates the uninsured future losses inherent in the
portfolio and discounts these losses to a present value at a current market
interest rate. The prior methodology resulted in or a reserve was
maintained to cover the uninsured future losses inherent in the
lease over the contractual life of the lease without discounting. The
adequacy of the reserve was assessed quarterly on an undiscounted basis,
and adjusted accordingly. Reserves for uninsured residual value losses on
direct financing automobile leases were $2.0 million, $1.7 million, and
$1.4 million at June 30, 2003, March 31, 2003, and December 31, 2002.
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). 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, 2002, and incorporated herein by reference.
4. 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, previously filed as exhibit 3(i) to annual
report on form 10-K for the year ended December 31, 1993
and exhibit 3(i)(c) to quarterly report on form 10-Q for
the quarter ended March 31, 1998, and incorporated
herein by reference. Also, reference is made to Rights
Plan, dated February 22, 1990, previously filed as
Exhibit 1 to Registration Statement on Form 8-A, and
incorporated herein by reference and to Amendment No. 1
to the Rights Agreement, dated as of August 16, 1995,
previously filed as Exhibit 4(b) to Form 8-K filed with
the Securities and Exchange Commission on August 28,
1995, and incorporated herein by reference. Instruments
defining the rights of holders of long-term debt will be
furnished to the Securities and Exchange Commission upon
request.
45
- - Benefit costs were increased by year-end accruals related to medical,
long-term disability, and pension expenses, which aggregated $5.7 million.
- - Personnel expense reflected a credit of $1.5 million in gains related to
stock received from the demutualization of certain insurance companies
where Huntington owned related insurance policies.
- - Occupancy expense included a $1.5 million reversal of an excess accrual for
real estate taxes.
- - Year-end Adjustments to accruals reduced total non-interest expense by
$0.7 million related to litigation, marketing, and charitable
contributions.
- - A recovery of previous trust losses totaled $0.8 million.
- - A legal settlement of $0.7 million related to amounts received or to be
received from a joint venture in which Huntington was a participant.
- - Impairment of an investment in an unconsolidated subsidiary totaled $3.9
million.
- - Huntington recorded a minimum pension liability associated with its
Supplement Income Retirement plan and various other benefit plans based on
its actuarial valuation dated September 30, 2002. The minimum pension
liability was recognized because the plan's accumulated benefit obligation
exceeded the fair value of its assets. A pension asset of $1.4 million was
recorded equal to the plan's unrecognized prior service cost. The amount of
the minimum pension liability that exceeded the pension asset, which
represented a net loss not yet recognized as a net period pension cost,
amounted to $0.2 million and was recorded as a reduction of equity, net of
applicable taxes, as a separate component of accumulated other
comprehensive income.
2003 First Quarter Item:
- - Huntington has purchased insurance to cover the difference between the
recorded residual value of automobiles leased to customers and the fair
value at the end of the lease term, as evidenced by Black Book valuation.
This insurance does not cover residual losses below Black Book valuation,
which may arise when the automobile has excess wear and tear and/or excess
mileage, not reimbursed by the lessee. Huntington maintains a reserve to
cover such losses on direct financing leases based on quarterly evaluations
of several factors, including vehicle type, lease terms, used automobile
market conditions, new product offerings, expected leased vehicle return
rates, and historical experience. In the first quarter of 2003, Huntington
changed its methodology for calculating the appropriate reserve level. The
revised methodology estimates the uninsured future losses inherent in the
portfolio and discounts these losses to a present value at a current market
interest rate. The prior methodology resulted in or a reserve was
maintained to cover the uninsured future losses inherent in the
lease over the contractual life of the lease without discounting. The
adequacy of the reserve was assessed quarterly on an undiscounted basis,
and adjusted accordingly. Reserves for uninsured residual value losses on
direct financing automobile leases were $2.0 million, $1.7 million, and
$1.4 million at June 30, 2003, March 31, 2003, and December 31, 2002.
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.
10. Material contracts:
(a)* Sixth Amendment to the Huntington Bancshares
Incorporated 1990 Stock Option Plan
(b)* Fourth Amendment to the Amended and Restated
Huntington Bancshares Incorporated 1994 Stock
Option Plan
12. Earnings to Fixed Charges
31.1 Rule 13a-14(a)/15d-14(a) Certification - Principal
Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification - Principal
Financial Officer
32.1 Section 1350 Certification - Principal Executive Officer
32.2 Section 1350 Certification - Principal Financial Officer
(b) Reports on Form 8-K
1. A report on Form 8-K, dated April 16, 2003, was filed under
report item numbers 5, 7, and 9, concerning Huntington's
results of operations for the first quarter ended March 31,
2003.
2. A report on Form 8-K, dated May 20, 2003, was filed under
report item numbers 5, 7, and 9, regarding Huntington's
filing of its amended 2002 annual report on Form 10-K/A and
its Form 10-Q for the first quarter ended March 31, 2003.
3. A report on Form 8-K, dated June 26, 2003, was filed under
report item numbers 5 and 7, concerning the staff of the
Securities and Exchange Commission conducting a formal
investigation of Huntington.
* Denotes management contract or compensatory plan or arrangement.
49
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 14, 2003 /s/ Thomas E. Hoaglin
-------------------------------------------
Thomas E. Hoaglin
Chairman, Chief Executive Officer and
President
Date: August 14, 2003 /s/ Michael J. McMennamin
-------------------------------------------
Michael J. McMennamin
Vice Chairman, Chief Financial Officer and
Treasurer (Principal Financial Officer)
50