10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on August 14, 2002
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, 2002
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 | |
There were 240,575,448 shares of Registrant's without par value common stock
outstanding on July 31, 2002.
HUNTINGTON BANCSHARES INCORPORATED
INDEX
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PART 1. FINANCIAL INFORMATION
Financial Statements
Consolidated Balance Sheets
See notes to unaudited consolidated financial statements.
3
Consolidated Statements of Income
(Unaudited)
See notes to unaudited consolidated financial statements.
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
See notes to unaudited consolidated financial statements.
5
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
See notes to unaudited consolidated financial statements.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated interim financial statements
include the accounts of Huntington and its subsidiaries and were prepared in
accordance with generally accepted accounting principles, and accordingly,
reflect all adjustments consisting of normal recurring accruals, which are,
in the opinion of management, necessary to fairly present Huntington's financial
position, results of operations, and cash flows for the periods presented. As
permitted by the SEC, these unaudited consolidated interim financial statements
do not include certain information and footnotes normally included in annual
financial statements. Accordingly, these unaudited consolidated interim
financial statements should be read in conjunction with Huntington's 2001
Annual Report on Form 10-K.
Certain amounts in the prior period's financial statements have been
reclassified to conform to the current presentation. These reclassifications
had no effect on net income.
NOTE 2 - 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 for stock options. The calculation of basic and
diluted earnings per share for each of the periods ended June 30, is as follows:
Approximately 3.1 million and 7.8 million stock options were outstanding
at the end of June 2002 and 2001, 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 $26.60 per share and $20.84 at the end of the same
respective periods.
NOTE 3 - INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board issued SFAS No.
141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets,
effective for fiscal years beginning after December 15, 2001. Under the new
rules, goodwill is no longer amortized but is subject to annual impairment tests
in accordance with the Statements. Other intangible assets continue to be
amortized over their useful lives. At June 30, 2002 and 2001, Huntington had
$210.7 million and $737.4 million in goodwill and other intangible assets,
respectively. The following table reflects the activity in goodwill and other
intangible assets for the three and six months ended June 30:
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The additions totaling $8.0 million for the second quarter of 2002 related
to the April 1st acquisition of Haberer Registered Investment Advisor, Inc.
(Haberer), a Cincinnati-based registered investment advisory firm. Haberer
became part of Huntington's Private Financial Group line of business as a wholly
owned subsidiary of Huntington. The sale of J. Rolfe Davis Insurance Agency,
Inc. (JRD) resulted in a reduction in goodwill of $7 million during the second
quarter of 2002.
Huntington applied the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002. In connection with the
adoption of SFAS No. 142, management assessed the fair values of its lines of
business in relation to their carrying value, including goodwill, in each line
of business. Based on this assessment, there was no impairment of goodwill or
other intangible assets. Huntington will continue to test for impairment on an
annual basis as prescribed by SFAS No. 142.
Before the sale of Huntington's operations in Florida, a majority of
goodwill and other intangible assets related to those operations. A substantial
portion of the remaining goodwill is attributable to the previously acquired
banking operations reported under the Regional Banking line of business. The
application of the non-amortization provisions of SFAS No. 142 resulted in an
increase in net income per share of $0.01 for the second quarter and $0.04 for
the first six months of 2002. Had no amortization of goodwill, net of tax, been
recorded in the prior year, net income and diluted earnings per share for the
second quarter of 2001 would have been greater by $7.7 million, or $0.03 per
share, and $15.5 million, or $0.06 per share, for the first half of 2001.
NOTE 4 - RESTRUCTURING AND SPECIAL CHARGES
In July 2001, Huntington announced a strategic refocusing plan (the
"Plan"). The Plan included the sale of Huntington's Florida banking and
insurance operations, the consolidation of numerous non-Florida branch offices,
as well as certain credit and other actions to strengthen Huntington's balance
sheet and financial performance, including the use of excess regulatory capital
generated by the sale to initiate a share repurchase program. During 2001,
Huntington provided $100.0 million of pre-tax expense to recognize a liability
for these actions and provided $71.7 million of additional allowance for loan
losses in connection with the Plan. In the first quarter of 2002, Huntington
provided an additional $56.2 million of pre-tax expense to recognize additional
liabilities related to the completion of the Plan.
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Huntington has a remaining liability of $22.8 million at June 30, 2002.
Huntington expects that the remaining liability will be adequate to fund the
estimated future cash outlays that are expected in the completion of the exit
activities contemplated by the Plan.
NOTE 5 - SALE OF FLORIDA OPERATIONS
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 $175.3 million and is reflected in non-interest
income. The after-tax gain was $56.8 million, or $0.22 per share. Income taxes
related to this transaction were $118.6 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. Pro forma financial
information reflecting the effect of the sale is presented and described below.
Since the transaction was completed during the first quarter of 2002, no pro
forma balance sheet is presented in this report.
The following unaudited pro forma consolidated income statement is
presented for the six months ended June 30, 2002, giving effect to the sale as
if it had occurred on January 1, 2002, and does not include the net gain
realized on the sale of Huntington's Florida operations or any related special
charges. These pro forma financial statements do not include any assumptions as
to future share repurchases pursuant to the previously announced share
repurchase program that commenced following the sale.
The pro forma consolidated income statement may not be indicative of the
results of operations that would have actually occurred had the transaction been
consummated during the period indicated. This pro forma financial information is
also not intended to be an indication of the results of operations that may be
attained in the future. These pro forma consolidated financial statements should
be read in conjunction with Huntington's historical financial statements.
UNAUDITED PRO FORMA CONSOLIDATED INCOME STATEMENT WITHOUT FLORIDA OPERATIONS
FOR THE SIX MONTHS ENDED JUNE 30, 2002
(1) Excludes after-tax gain on sale of the Florida operations and
restructuring and special charges.
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The column entitled Florida Operations includes all direct revenue and
expenses for Florida from January 1, 2002 through February 15, 2002, the results
of operations for JRD for the six months period ended June 30, 2002, and any
indirect revenue and expenses that ceased with the sale of the Florida
operations, including $1.1 million of amortization expense on intangible assets
related to Florida. In addition, net interest income in that column includes:
(1) a funding credit of $5.3 million related to $2.0 billion of funding that
Florida provided to Huntington and (2) $1.9 million of interest that would have
been earned on the $711.9 million deposit premium from January 1, 2002 through
February 15, 2002. Both the funding credit and the assumed interest earned on
the deposit premium are based on the average one-year LIBOR rate of 2.15% for
the period. The column entitled Related Transactions reflects the $175.3 million
net gain on the sale of the Florida operations, $32.7 million of the $56.2
million special charges recorded in the first quarter of 2002 that related to
the sale of Florida, and the applicable income taxes. After excluding the
remaining restructuring and special charges, net of taxes, operating earnings
were $161.2 million and earnings per share was $0.65 for the first half of 2002.
NOTE 6 - AVAILABLE FOR SALE SECURITIES
Securities available for sale at June 30, 2002 and December 31, 2001 were
as follows:
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NOTE 7 - COMPREHENSIVE INCOME
Comprehensive Income includes net income as well as certain items that are
reported directly within a separate component of stockholders' equity that are
not considered part of net income. Currently, Huntington's only components of
Other Comprehensive Income are the unrealized gains (losses) on securities
available for sale and unrealized gains and losses on certain derivatives. The
related before and after tax amounts are as follows:
Activity in Accumulated Other Comprehensive Income for the six months
ended June 30, 2002 and 2001 was as follows:
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NOTE 8 - SEGMENT REPORTING
Huntington views its operations as four distinct segments. Regional
Banking, Dealer Sales, and the Private Financial Group (PFG) are Huntington's
major business lines. The 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 business profitability
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. During the first quarter of 2002, the previously reported Retail
Banking and Corporate Banking segments were combined and renamed Regional
Banking. Since this segment is managed through six geographically defined
regions where each region's management has responsibility for both retail and
corporate banking business development, combining these two previous segments
better reflects the management accountability and decision making structure. In
addition, changes were made to the methodologies utilized for certain balance
sheet and income statement allocations performed by Huntington's business
profitability reporting system. The prior quarters have not been 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 exclude the the gain from the sale of the Florida operations, the
historical Florida results, and restructuring and special charges. See Note 4 to
the unaudited consolidated financial statements for further discussions
regarding restructuring and special charges and Note 5 for the net gain on sale
of Huntington's Florida operations. Net interest income is presented on a fully
tax equivalent (FTE) basis using a 35% tax rate.
The following provides a brief description of the four operating segments of
Huntington:
REGIONAL BANKING: provides products and services to retail, business
banking, and corporate 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 through Huntington's
traditional banking network; Direct Bank--Huntington's customer service center;
and Web Bank at www.huntington.com. Regional Banking also represents the
middle-market and large corporate banking relationships which use a variety of
banking products and services including, but not limited to, commercial loans,
international trade, and cash management.
DEALER SALES: product offerings pertain to the automobile lending sector
and include indirect consumer loans and leases, as well as floor plan financing.
The consumer loans and leases comprise the vast majority of the business and
involve the financing of vehicles purchased or leased by individuals through
dealerships.
PRIVATE FINANCIAL GROUP: this segment's array of products and services are
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 cannot be 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.
Additionally, amortization expense of intangible assets and gains or losses not
allocated to other business segments are also a component.
Listed below is certain reported financial information reconciled to
Huntington's second quarter and six-month 2002 and 2001 operating results by
line of business.
12
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NOTE 9 - NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board (FASB) issued
Statement No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections. This Statement rescinds
Statement No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an
amendment of that Statement, Statement No. 64, Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements. This Statement also rescinds Statement No.
44, Accounting for Intangible Assets of Motor Carriers. This Statement amends
Statement No. 13, Accounting for Leases, to eliminate an inconsistency between
the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. This Statement also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. As a
result, gains and losses from extinguishment of debt are classified as
extraordinary items only if they meet the criteria in Accounting Principles
Bulletin (APB) Opinion 30. Applying the provisions of APB Opinion 30 will
distinguish transactions that are part of an entity's recurring operations from
those that are unusual or infrequent or that meet the criteria for
classification as an
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extraordinary item. In addition, this Statement requires lease modifications to
be accounted for in the same manner as sale-leaseback transactions.
In June 2002, the FASB issued Statement No. 146, Accounting for Costs
Associated with Exit Activities. This Statement addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). This Statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized using fair value when the liability is incurred. The
provisions of this Statement are effective for exit or disposal activities that
are initiated after December 31, 2002, with early application encouraged.
The adoption of Statements No. 145 and No. 146 are not expected to have a
material impact on Huntington's results of operations or financial condition.
NOTE 10 - SUBSEQUENT EVENTS
On July 18, 2002, Huntington announced the restructuring of its interest
in Huntington Merchant Services, L.L.C. (HMS), Huntington's merchant services
business, in a transaction with First Data Merchant Services Corporation, a
subsidiary of First Data Corp. This transaction resulted in an approximate $25
million pre-tax, non-operating gain ($16 million after tax). Under the
agreement, First Data obtained all of Huntington's Florida-related merchant
business and increased its equity interest in HMS. In addition, as part of the
transaction, Huntington extended its long-term merchant services relationship
with First Data. Huntington remains a nominal equity owner.
On July 2, 2002, Huntington closed the sale of the Orlando, Florida-based
JRD to members of its management team. Huntington acquired JRD in August of 2000
and operated it as a stand-alone property and casualty insurance agency within
Huntington's insurance operations. Huntington's decision to sell JRD is
consistent with its strategic refocusing plan.
These transactions are not expected to have a material impact on
Huntington's future financial results.
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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 financial
holding company headquartered in Columbus, Ohio. Its subsidiaries are engaged in
full-service commercial and consumer banking, mortgage banking, lease financing,
trust services, discount brokerage services, underwriting credit life and
disability insurance, issuing commercial paper guaranteed by Huntington, and
selling other insurance and financial products and services. Its subsidiaries
operate domestically in offices located predominately in Ohio, Michigan, West
Virginia, Indiana, and Kentucky. Huntington has a foreign office in the Cayman
Islands and in Hong Kong.
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, or other measures of economic performance. Forward-looking
statements can be identified by the fact that they do not relate strictly to
historical or current facts.
By their nature, forward-looking statements are subject to numerous
assumptions, risks, and uncertainties. A number of factors, including but not
limited to, those set forth under the heading "Business Risks" included in Item
1 of Huntington's 2001 Annual Report and other factors described from time to
time in other filings with the Securities and Exchange Commission, could cause
actual conditions, events, or results to differ significantly from those
described in the forward-looking statements.
Management encourages readers of this interim report on Form 10-Q to
understand forward-looking statements to be strategic objectives rather than
absolute targets 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.
The following discussion and analysis, the purpose of which is to provide
investors and others with information that management believes to be necessary
for an understanding of Huntington's financial condition, changes in financial
condition, and results of operations, and should be read in conjunction with the
financial statements, notes, and other information contained in this document.
SIGNIFICANT ACCOUNTING POLICIES
Note 1 to the consolidated financial statements included in Huntington's
2001 Annual Report 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, and results of operations.
SPECIAL PURPOSE ENTITIES (SPES)
Huntington utilized two securitization trusts, or SPEs, in 2000 as funding
sources. In the securitization transactions, indirect auto loans that Huntington
originated were sold to these trusts in exchange for funding collateralized by
these loans. Under GAAP, these trusts are not consolidated in Huntington's
financial statements. As such, the loans and the funding obtained are not
included on Huntington's balance sheets.
The Financial Accounting Standards Board (FASB) has approved for
issuance an Exposure Draft of a proposed Interpretation to ARB No. 51 that
establishes accounting guidance for consolidation of SPEs. The proposed
Interpretation, Consolidation of Certain Special-Purpose Entities, will apply to
any business enterprise--both public and private companies--that has an
ownership interest, contractual relationship, or other business relationship
with an SPE. The comment period on this Exposure Draft concludes August 30,
2002.
The objective of this proposed Interpretation is to improve financial
reporting by enterprises involved with SPEs--not to restrict the use of SPEs.
Current accounting standards require an enterprise to include subsidiaries in
which it has a controlling financial interest in its consolidated financial
statements. The FASB expects to issue a final Interpretation in the fourth
quarter of this year. The accounting guidance would be effective immediately
upon issuance of the
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Interpretation for new SPEs. Companies such as Huntington with SPEs that existed
before the issuance of the Interpretation would be required to apply the
guidance to the existing SPEs at the beginning of the first fiscal period after
March 15, 2003. Calendar year-end companies would need to apply the guidance on
April 1, 2003.
Huntington is in the initial stages of assessing the implications of this
Interpretation as it applies to the consolidation of the securitization trusts
and its impact to results of operations and financial condition.
OTHER OFF BALANCE SHEET ARRANGEMENTS
Like other financial organizations, Huntington uses various commitments in
the ordinary course of business that, under generally accepted accounting
principles in the United States (GAAP), are not recorded in the financial
statements. Specifically, Huntington makes various commitments to extend credit
to customers and to sell loans, and have obligations under operating-type
noncancelable leases for its facilities.
DERIVATIVES
Huntington uses a variety of derivatives, principally interest rate swaps,
in its asset and liability management activities to protect against the risk of
adverse interest rate movements on either cash flows or market value of certain
assets and liabilities. This, along with other information regarding
derivatives, is discussed under the "Interest Rate Risk Management" section of
this report and in the notes to the unaudited consolidated financial statements.
RELATED PARTY TRANSACTIONS
Various directors and executive officers of Huntington are customers of
its bank subsidiary, The Huntington National Bank (the Bank), and other
affiliates and conducted transactions with these affiliates in the ordinary
course of business. Directors and executive officers may also be affiliated with
entities that are the Bank's customers and Huntington's other affiliates, which
enter into transactions with these affiliates in the ordinary course of
business. A summary of the indebtedness of management can be found in Note 4 to
Huntington's 2001 Annual Report. All other related party transactions, including
those reported in Huntington's 2002 Proxy Statement, were considered immaterial
to its financial condition and results of operations.
STRATEGIC REFOCUSING AND OTHER RESTRUCTURING
In July 2001, Huntington announced a strategic refocusing plan (the Plan).
Key components of the Plan included the intent to sell the Florida banking and
insurance operations, the consolidation of numerous non-Florida branch offices,
as well as credit-related and other actions to strengthen its balance sheet and
financial performance including the use of some of the excess capital to
repurchase outstanding common shares. These initiatives were designed to attain
more positive revenue and earnings for shareholders and to improve capital
efficiency.
The sale of the Florida banking operations to SunTrust Banks, Inc., closed
February 15, 2002, and included 143 banking offices and 456 ATMs with
approximately $2.8 billion in loans and other tangible assets, and $4.8 billion
in deposits and other liabilities. The transaction slightly increased
Huntington's sensitivity to rising interest rates. In addition, the net interest
margin, tangible equity to assets, and efficiency ratios were favorably
impacted.
The sale of the Florida insurance operations involved the sale of
Orlando-based J. Rolfe Davis Insurance Agency, Inc. (JRD), which closed on July
2, 2002, to members of its management team. Huntington remains committed to
growing the insurance business in markets served by its retail and commercial
banking operations. The JRD sale will not materially affect future financial
results.
On February 19, 2002, Huntington announced a new share repurchase program
authorizing the repurchase of up to 22 million shares. Repurchased shares will
be reserved for reissue in connection with Huntington's dividend reinvestment
and employee benefit plans, as well as for acquisitions and other corporate
purposes. Through the end of June 2002, approximately 8.8 million shares of
common stock were repurchased, including 6.9 million shares in the second
quarter through open market and privately negotiated transactions.
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During the first quarter of 2002, $56.2 million of pre-tax restructuring
and special charges ($36.5 million after-tax, or $0.14 per share) were recorded
related to the Plan. Combined with amounts recorded in 2001, these pre-tax
charges totaled $233.1 million ($151.5 million after-tax, or $0.60 per share).
In the first quarter of 2002, a pre-tax gain of $175.3 million ($56.7 million
after-tax, or $0.23 per share) on the sale of the Florida operations was
recorded. Further information regarding the financial impact of the Plan can be
found in Notes 4 and 5 to the unaudited consolidated financial statements.
SUMMARY DISCUSSION OF RESULTS
Huntington reported second quarter 2002 earnings of $82.2 million, or
$0.33 per common share. This compares with earnings of $2.4 million, or $0.01
per common share, in the year-ago second quarter, and $97.7 million, or $0.39
per common share, in the first quarter of 2002. Year-to-date earnings in 2002
were $180.0 million, or $0.72 per common share, compared with $70.2 million, or
$0.28 per common share, in the comparable year-ago six-month period.
On an operating basis (see Basis of Discussion - Operating Earnings
below), second quarter 2002 earnings were $81.7 million, or $0.33 per common
share, up 8% and 10%, respectively, compared with the year-ago second quarter's
operating earnings of $75.6 million, or $0.30 per share. Second quarter
operating net income and earnings per common share were both up 3% from first
quarter operating earnings of $79.5 million, or $0.32 per common share.
Operating earnings for the first six months of 2002 were $161.2 million, or
$0.65 per common share, up 10% and 12%, respectively, from the comparable
prior-year period operating earnings of $147.1 million, or $0.58 per common
share.
The primary contributing factors to the $6.1 million, or 8%, increase
in operating net income from the year-ago quarter was higher net interest
income, the benefit of which was partially offset by higher provision for loan
losses. Net interest income increased $16.0 million, or 7%, reflecting the
benefit of a higher net interest margin as well as loan and deposit growth. The
provision for loan losses increased $12.0 million, or 29%. The increase in the
provision for loan losses over the prior year quarter reflected higher net
charge-offs and a higher level of loans. Second quarter results compared with
the year-ago quarter also benefited, but to a lesser degree, from a $1.7
million, or 1%, increase in non-interest income, and a $2.3 million, or 1%,
decline in non-interest expense. Income tax expense increased $1.8 million from
the year-ago quarter, reflecting the current quarter's higher level of net
income.
Second quarter 2002 performance measures on an operating basis all
improved from the same quarter of last year. This included the return on average
equity (ROE) that increased from 12.6% to 14.0%, the return on average total
assets (ROA) that increased from 1.20% to 1.31%, an increase in the net interest
margin from 4.03% to 4.30%, and an improvement in the efficiency ratio from
56.0% to 53.2%. (See the Results of Operations discussion below for a complete
discussion).
BASIS OF DISCUSSION - OPERATING EARNINGS
Reported results for the past five quarters have been significantly
impacted by a number of items, primarily related to the strategic refocusing
announced in July 2001 and the subsequent sale of the Florida banking and
insurance operations in 2002. Reported 2002 first quarter results also included
Florida operations for only half the quarter versus a full quarter for each
prior quarter. Therefore, to better understand comparable underlying trends, the
following discussion is on an operating basis. Specifically, operating earnings
exclude the impact of restructuring and other charges, the gain on the sale of
the Florida operations, and excludes the run-rate impact of the sold Florida
banking and insurance operations.
The table on page 19 reconciles reported with operating results for the
second quarter and first six months of 2002 and 2001. The table on page 20
entitled Selected Quarterly Income Statement Data, excluding Florida Operations,
shows operating results beginning with the first quarter of 2001 through the
current quarter. The following tables differ from the table presented in Note 5
to the unaudited consolidated income statements for the six months ended June
30, 2002. The tables below reconcile reported earnings to operating earnings and
therefore exclude the impact of Florida banking and insurance operations and
both Florida-related and non-Florida related restructuring charges. The table
in Note 5 presents Huntington on a pro forma basis without the Florida banking
and insurance operations and the Florida-related restructuring charges and
therefore includes $23.5 million of non-Florida related restructuring charges.
RESULTS OF OPERATIONS
For decision-making purposes, management reviews and analyzes financial
results on an operating basis, which leads to a better understanding of
underlying trends absent the impact of revenue and costs involved in the
strategic refocusing plan announced in July 2001 and the run-rate impact of the
Florida operations. Current and prior year results
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contained a number of such items. The Results of Operations discussion that
follows is on an operating basis, except as otherwise stated. (See Basis of
Discussion - Operating Earnings above for an expanded discussion of operating
results and reconciliation to reported results.)
19
SELECTED QUARTERLY INCOME STATEMENT DATA, EXCLUDING FLORIDA OPERATIONS
(1) Income component excludes after-tax impact of the $56.8 million gain on
sale of Florida operations in 1Q '02 and restructuring and special charges
($36.5 million in 1Q '02; $9.8 million in 4Q '01; $33.0 million in 3Q '01;
$72.1 million in 2Q '01).
(2) Calculated assuming a 35% tax rate.
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NET INTEREST INCOME
Net interest income was $241.9 million in the second quarter of 2002, up
7% from the year-ago quarter reflecting a 27 basis point increase in the net
interest margin to 4.30% from 4.03%. The margin increase was due to a
substantial reduction in short-term interest rates and the related steepening of
the yield curve, as well as the maturity in late 2001 of certain interest rate
swaps that had negative spreads. Earning assets were essentially unchanged. (See
net interest margin detail and average balance sheets for the recent five
quarters on the following page.) Average managed loans, which include $1.2
billion of securitized auto loans, increased 5% after normalizing for
residential real estate loan securitizations and the impact of Florida banking
operations sold in the first quarter of 2002. However, this positive was largely
offset by a planned decline in other earning assets, most notably low-yielding
investment securities. A key strategy implemented last year was to improve the
earning asset yield by reducing the level of low-margin investment securities.
Investment securities averaged $2.8 billion in the second quarter of 2002, down
21% from the year-ago quarter. As a result of this decrease, securities
represented 13% of average earning assets in the second quarter of 2002, down
from 16% in the year-ago quarter. Average core deposits were up 13% from the
year-ago quarter, reflecting a 42% increase in money market and other interest
bearing deposits and a 7% increase in other domestic time deposits. Deposit
inflow has been influenced, in part, by turbulence in the financial markets, but
also by the success of sales and deposit growth programs.
Compared with the 2002 first quarter, net interest income increased $8.8
million, or 4%, reflecting a 9 basis point increase in the net interest margin
to 4.30% and a $237 million, or 1%, increase in average earning assets. The
increase in the net interest margin was driven by seasonally higher loan fees
and the positive impact of the interest rate environment, including a
continuation of an upsloping yield curve, partially offset by a reduced benefit
from the lagged repricing of the variable rate home equity loan portfolio.
Average managed loans, normalized for residential real estate loan
securitizations and the impact of Florida banking operations sold in the 2002
first quarter, grew at a 7% annualized rate during the quarter, but this benefit
was partially offset by a decline in other earning assets, primarily mortgages
held for sale. Average core deposits increased $657.4 million, or at a 19%
annualized rate from the first quarter, reflecting continued strong inflows in
interest bearing and other domestic time deposits.
The average managed loans increase continued to be positively impacted by
strong growth in residential mortgages and home equity loans and lines of
credit. Average residential mortgages grew $325.1 million, reflecting a decision
to retain more of these loans on the balance sheet, with home equity loans and
lines of credit up $122.5 million, or at a 17% annualized rate. This reflected
continued strong demand for residential mortgages, refinancing activity, and the
promotion of adjustable mortgage products. Commercial real estate loans
increased $51.8 million, or at a 6% annualized rate, slower than the 15% and 18%
annualized rates in the 2002 first quarter and 2001 fourth quarter,
respectively. These increases were partially offset by declines in other loan
categories reflecting the continued weakness in the economy and certain sectors.
This was especially noticeable in the $47.5 million, or 3% annualized decline in
commercial loans and $50.6 million, or 3% annualized, decline in managed auto
loans and leases.
For the first six months of 2002, net interest income was $475.0 million,
up $27.1 million, or 6%, from the comparable year-ago period. This reflected a
25 basis point increase in the net interest margin to 4.26% from 4.01% as
average earning assets for the first six months of 2002 were essentially
unchanged from the first six months of last year. Comparisons of average earning
assets, loans, investment securities, and deposits for the first six months of
2002 versus the comparable year-ago period reflect the same factors that
affected second quarter comparisons.
PROVISION FOR LOAN LOSSES
The provision for loan losses is the expense necessary to maintain the
allowance for loan losses (ALL) at a level adequate to absorb management's
estimate of inherent losses in the loan portfolio. The provision expense in the
second quarter of 2002 was $53.9 million, up $12.0 million, or 29%, from the
year-ago quarter. This increase reflected loan growth and higher levels of net
charge-offs, and continued economic weakness. At June 30, 2002, the allowance
for loan losses as a percent of period-end loans was 2.00%, up from 1.76% at the
end of the year-ago quarter. (See Credit Risk section for discussion of the ALL,
NPAs and Net charge-offs.)
Compared with the first quarter of this year, the provision for loan
losses increased $3.3 million, and exceeded net charge-offs by $9.0 million,
providing for loan growth as the allowance for loan losses as a percent of
period-end loans was unchanged at 2.00%.
For the first six months of 2002, the provision for loan losses was $104.5
million, up from $71.6 million from the first six months of 2001, reflecting
the same factors that affected second quarter comparisons.
21
CONSOLIDATED QUARTERLY NET INTEREST MARGIN DETAIL AND AVERAGE BALANCES
(in millions)
(1) Fully tax equivalent yields are calculated assuming a 35% tax rate.
(2) Total loans with fees rate includes loan fees, whereas individual loan
components above are shown exclusive of fees.
(3) Loan and deposit average rates include impact of applicable derivatives.
22
NON-INTEREST INCOME BEFORE SECURITIES GAINS
Non-interest income before securities gains in the second quarter of 2002
was up $3.4 million, or 3%, from the year-ago quarter despite a $6.9 million, or
39%, decline in mortgage banking income. This reduction in mortgage banking
income reflected a 61% decline in deliveries to the secondary market, primarily
to retain more residential mortgage loans on the books. Excluding mortgage
banking income, second quarter non-interest income before securities gains was
up $10.4 million, or 11%, from the second quarter of last year. The following
table reflects non-interest income detail for the three and six months ended
June 30, 2002 and 2001:
NON-INTEREST INCOME
All remaining non-interest income categories experienced significant
growth from the year-ago quarter. This included a $2.7 million or 8% increase in
deposit service charges, primarily driven by higher corporate maintenance fees.
Brokerage and insurance income was up $1.8 million, or 14%, from the year-ago
quarter primarily due to strong retail investment sales, the benefit of which
was partially offset by lower investment banking and insurance fees. Trust
income was up $1.8 million, or 13%, reflecting the impact of the acquisition of
Haberer Registered Investment Advisors, Inc. (Haberer) in the 2002 first
quarter. The increase in brokerage and insurance income was due to increased
sales of mutual funds and annuities. Income from bank owned life insurance was
up $1.9 million, or 20%. Other service charges increased $1.1 million, or 12%,
reflecting increased debit card and ATM fees. Other income increased $1.1
million, or 8%, reflecting a combination of higher securitization income and a
gain on the sale of a real estate property, which was partially offset by lower
sales of customer derivative products.
Compared with the first quarter of 2002, non-interest income before
securities gains was down $0.7 million, reflecting an $8.9 million decline in
mortgage banking income. Similar to comparisons to the year-ago quarter, this
decline reflected a 64% decrease in deliveries to the secondary market from the
first quarter's very strong performance, and to a lesser degree, a decision to
retain a higher percentage of loans on the balance sheet. Excluding mortgage
banking, non-interest income before securities gains was up $8.2 million, or 9%,
from the first quarter reflecting broad-based increases in other fee income
categories.
Trust income in the second quarter of 2002 was up $1.2 million, or 8%,
from the first quarter, mostly reflecting the impact from the Haberer
acquisition. Corporate trust income increased 26%, largely due to the
seasonality of annual
23
renewal fees and institutional sales activities. Partially offsetting these
increases was the impact of declining asset values. Deposit service charges were
up $1.1 million, or 3%, with the primary driver being higher personal service
charges, especially NSF and overdraft fees. Other service charges were up $1.4
million, or 15%, from the first quarter, reflecting increased ATM and debit card
fees. Other income was up $4.4 million reflecting higher securitization income
and a gain on the sale of a real estate property, partially offset by lower
sales of customer derivative products.
For the first six months of 2002, non-interest income before securities
gains was $229.3 million, up 11% from the comparable year-ago period,
reflecting the same factors that affected second quarter comparisons.
SECURITIES GAINS
Securities gains in the second quarter of 2002 were $1.0 million, down
from $2.7 million in the year-ago quarter and up $0.5 million from the first
quarter of 2002. The gains in the year-ago quarter resulted from investment
securities sold reflecting a strategy to reduce low-margin investment
securities. For the first half of 2002, securities gains were $1.4 million, down
from $4.8 million in the first six months of last year.
NON-INTEREST EXPENSE
Non-interest expense was $190.2 million in the second quarter of 2002,
down $2.3 million, or 1%, from the year-ago quarter. This reflected a $2.7
million decline in intangible amortization expense primarily related to the
reduction of non-Florida operations related intangible amortization due to
implementing SFAS No. 142, described more fully in Note 3 to the unaudited
consolidated financial statements. The following table reflects non-interest
expense detail for the three and six months ended June 30, 2002 and 2001:
NON-INTEREST EXPENSE
Personnel costs were essentially flat for the recent quarter when compared
with the year-ago quarter, reflecting the benefit of a 5% decline in period-end
full-time equivalent staff due to planned staff reductions. These were partially
offset by higher sales commission expense. The following table reflects the
number of full-time equivalent staff at the end of each period shown.
Approximately 1,200 full-time equivalent staff were associated with the Florida
banking operations sold in the 2002 first quarter. The 168 full-time equivalent
decrease in staff from March 31, 2002 to June 20,
24
2002, reflected planned staff reductions, primarily Florida-related operations
support staff located outside the state of Florida and not part of the sold
banking operations.
Outside data processing and other services expense increased $1.5 million,
or 10% from the prior year quarter, reflecting higher processing expenses
related to Huntington's loan and deposit products. On a combined basis,
occupancy and equipment costs were up slightly from the year-ago quarter
reflecting higher depreciation associated with technology investments including
a new Internet-banking platform launched in the first quarter of this year,
costs associated with the implementation of a new Customer Service System to
assist personal bankers in branches in providing quicker and more comprehensive
customer service, as well as enhanced product sales capabilities, and mainframe
infrastructure upgrades, which was partially offset by lower depreciation and
building maintenance costs primarily related to planned branch consolidations.
Compared with the first quarter of 2002, non-interest expense was up $1.1
million, or 1%, driven by a $0.9 million increase in occupancy and equipment
costs and a $1.0 million increase in professional services. These increases were
partially offset by a $0.7 million decrease in personnel costs, reflecting, in
part, a 2% decline in full-time equivalent staff from March 31 to June 30 due to
planned staff reductions, and a $0.5 million decline in outside services.
For the first half of 2002, non-interest expense was $379.2 million, down
from $386.3 million, or 2%, reflecting these same factors.
The combination of lower expenses as well as higher revenues positively
affected the efficiency ratio, which expresses expenses (excluding amortization
of intangible assets) as a percentage of revenues (before gains on securities
transactions) on a tax-equivalent basis. The efficiency ratio improved to 53.2%
in the second quarter of 2002 from 56.0% in the year-ago quarter and 54.1% in
the first quarter of 2002.
INCOME TAXES
The provision for income taxes in the second quarter of 2002 was $31.3
million and represented an effective tax rate on income before taxes of 27.7%.
This compares to a provision for income taxes in the year-ago quarter of $29.5
million, or 28.1% of income before taxes, and $29.4 million, or 27.0% in the
2002 first quarter.
CREDIT RISK
Credit risk exposure is managed through the use of consistent underwriting
standards, policies that limit exposure to higher risk credits (e.g. highly
leveraged transactions or nationally syndicated credits), and a strategy of
diversification of exposure by industry sector, geographic region, or other
concentrations. Management has focused its commercial lending to customers with
multiple relationships with the Bank. As a result, outstanding shared national
credits declined to $1.0 billion at June 30, 2002 from $1.5 billion one year
ago. The credit administration function employs extensive credit risk management
techniques, including forecasting, to ensure loans adhere to corporate policy
and problem loans are promptly identified. The loss forecasting process is
performed on a monthly basis to ensure that all changes in the portfolio's
composition and performance are incorporated. These procedures provide executive
management with the information necessary to implement policy adjustments where
necessary, and take corrective actions on a proactive basis.
LOAN COMPOSITION
The following table shows the period-end reported loan portfolio by loan
type and business segment, with the latter including a separate line indicating
loans sold with the Florida banking operations in the first quarter of 2002:
25
NON-PERFORMING ASSETS
Non-performing assets (NPAs) consist of loans that are no longer accruing
interest, loans that have been renegotiated based upon financial difficulties of
the borrower, and real estate acquired through foreclosure. Commercial and real
estate loans stop accruing interest when collection of principal or interest is
in doubt or generally when the loan is 90 days past due. When interest accruals
are suspended, accrued interest income is reversed with current year accruals
charged to earnings and prior year amounts generally charged off as a credit
loss. Consumer loans are not placed on non-accrual status but are charged off in
accordance with regulatory statutes, which is generally no more than 120 days.
The following table summarizes NPAs at the end of each of the recent five
quarters in addition to past due information:
26
Total NPAs were $223.2 million at June 30, 2002, up from $156.9 million at
the end of the year-ago quarter, but down slightly from $225.5 million at the
end of the first quarter of 2002. The adverse impact was primarily from the
uncertain economic environment in the Midwest, particularly in the manufacturing
and service sectors, primarily resulted in the NPA increase from the year-ago
period. NPAs as a percent of total loans and other real estate were 1.14% at
June 30, 2002, up from 0.85% a year go, but down slightly from 1.17% at March
31, 2002.
Loans past due ninety days at the end of the second quarter of 2002 were
$58.4 million and represented 0.30% of total loans. This was up slightly from
$54.2 million, or 0.29% at June 30, 2001, but down slightly from $61.7 million,
or 0.32% of total loans at March 31, 2002.
NET CHARGE-OFFS
In the second quarter of 2001, as part of the strategic restructuring
plan, a decision was make to exit the sub-prime automobile lending, as well as
truck and equipment lending businesses. At that time, special credit loss
reserves were established to cover the inherent losses in those portfolios and
to which related loan losses have been charged.
Excluding charge-offs related to these exited businesses, net charge-offs
in the second quarter of 2002 were $42.5 million and represented an annualized
0.88% of average loans. This was up from $34.3 million, or 0.74%, in the
year-ago quarter, but down from $45.5 million, or 1.07%, in the first quarter of
2002.
The $8.2 million increase in net charge-offs from the year-ago quarter
reflected a $12.3 million increase in commercial and commercial real estate net
charge-offs, partially offset by a $4.1 million decline in consumer net
charge-offs. The increase in commercial net charge-offs primarily reflected the
impact of the weakened economy while the decline in consumer net charge-offs
primarily reflected lower auto lease and loan losses as a result of a management
decision over the last two years to strengthen the underwriting criteria and
credit score mix of new auto loan and lease originations.
The following table reflects net charge-offs and annualized charge-offs as
a percent of average loans by type of loan:
27
Management believes consumer net charge-offs could generally improve
slightly from second quarter performance through the end of 2002 reflecting the
decline in consumer delinquencies in recent months and the continued positive
impact from higher quality auto loan and lease originations over the last
several quarters. However, given the recent decline in charge-offs and the
normal seasonal patterns, we expect that charge-offs may increase in the short
run. The outlook for commercial net charge-offs is for gradual improvement.
This expected improvement could be mitigated in the short run should
opportunities exist to accelerate the resolution and/or exiting of certain
troubled credits.
ALLOWANCE FOR LOAN LOSSES
The ALL was $393.0 million at June 30, 2002, up from $326.5 million at the
end of the second quarter of 2001, and $386.1 million at March 31, 2002. The ALL
represented 2.00% of total loans at June 30, 2002, up from 1.76% at the end of
the second quarter last year, but unchanged from March 31, 2002. The period-end
ALL was 185% of NPAs at June 30, 2002, down from 222% a year ago, but up from
176% at March 31, 2002.
28
The following table reflects the activity in the ALL for the recent five
quarters, excluding the Florida operations, and the ALL of $22.3 million related
to $2.8 billion of loans sold in conjunction with the sale of Florida during the
first quarter of 2002.
The provision for loan losses for the second quarter of 2001 included
additional charges of $71.7 million to recognize the estimated embedded losses
resulting from Huntington's decision to exit sub-prime automobile lending and
truck and equipment lending, to charge-off delinquent consumer and small
business loans more than 120 days past due, to increase reserves for consumer
bankruptcies, and to increase commercial loan reserves. The provision for loan
losses for the fourth quarter of 2001 included $50.0 million of charges to
increase the loan loss reserve in light of the higher charge-offs and
non-performing assets experienced in the second half of 2001.
The ALL is allocated to each loan category based on expected losses.
Expected losses are a function of the likelihood of default and the loss in the
event of default. A continuous assessment of credit quality is based on
portfolio risk characteristics and other relevant factors such as historical
performance, internal controls, and impacts from mergers and acquisitions. For
the commercial and industrial and commercial real estate credits, expected loss
factors are assigned by credit grade at the individual loan level and are
updated monthly. The aggregation of these factors represents management's
estimate of the inherent loss. The portion of the allowance allocated to the
more homogeneous consumer loan segments is determined by developing expected
loss ratios based on the risk characteristics of the various segments and giving
consideration to existing economic conditions and trends.
Projected loss ratios incorporate factors such as trends in past due and
non-accrual amounts, recent loan loss experience, current economic conditions,
risk characteristics, and concentrations of various loan categories. Actual loss
ratios experienced in the future, however, could vary from those projected as a
loan's performance is a function of not only economic factors but also other
factors unique to each customer. The dollar exposure could significantly vary
from estimated amounts due to losses from large dollar single client exposures,
industry, product, or geographic concentrations, or changes in general economic
conditions. To ensure adequacy to a higher degree of confidence, a portion of
the ALL is considered unallocated. While amounts are allocated to various
portfolio segments, the total ALL, excluding impairment reserves prescribed
under provisions of Statement of Financial Accounting Standard No. 114, is
available to absorb losses from any segment of the portfolio. Unallocated
reserves are based on levels of criticized/classified assets, delinquencies in
the accruing loan portfolios, the level of non-performing loans, and general
economic conditions and volatility. Total unallocated reserves were 13% at June
30, 2002, versus 11% one year ago.
INTEREST RATE RISK MANAGEMENT
Huntington seeks to achieve consistent growth in net interest income and
net income while managing volatility arising from shifts in interest rates. The
Board of Directors and Asset and Liability Management Committee (ALCO) oversee
financial risk management by establishing broad policies and specific operating
limits that govern a variety of financial risks inherent in Huntington's
operations, including liquidity, counterparty, settlement, and market risks.
Market risk is the potential for declines in the fair value of financial
instruments due to changes in interest rates and
29
equity prices. Interest rate risk is Huntington's primary market risk and
results from the timing differences in the repricing of assets and liabilities,
changes in relationships in asset and liability repricing and the potential
exercise of explicit or embedded options.
Interest rate risk management is a dynamic process, encompassing new
business flows onto the balance sheet, prepayments/maturities of existing assets
and liabilities, wholesale investments and funding, and the changing market and
business environment. To accomplish its overall balance sheet objectives,
Huntington regularly accesses a variety of global markets--money, bond, swaps,
futures, and options. ALCO regularly monitors position concentrations and the
interest rate sensitivity to ensure compliance with approved risk tolerances.
Measurement and monitoring of interest rate risk is an ongoing process.
Two key elements used in this process are an income simulation model and a net
present value model. The income simulation model is designed to capture interest
rate risk over the short term i.e., changes in net interest income over the next
12 months resulting in changes in interest rates. The net present value model,
or Economic Value of Equity (EVE), is designed to capture the impact of changes
in interest rates over the entire life of the assets and liabilities thus, the
EVE model captures the impact of changing weights on assets and liabilities
beyond the one-year timeframe of the income simulation model. EVE risk is
measured using a static balance sheet under interest rate shock scenarios.
Assumptions used in these models are inherently uncertain, but management
believes that these models provide a reasonably accurate estimate of
Huntington's interest rate risk exposure.
The income simulation model captures all major assets, liabilities, and
off-balance sheet financial instruments, accounting for significant variables
that are believed to be affected by interest rates. These include prepayment
speeds on mortgages and consumer installment loans, cash flows of loans and
deposits, principal amortization on revolving credit instruments, and balance
sheet growth assumptions. The model also captures options embedded in balance
sheet assets and liabilities, e.g. interest rate caps/floors or call options,
and changes in rate relationships, as various rate indices lead or lag changes
in market rates.
The income simulation model calculates the change in net interest income
for the next twelve months resulting from a gradual (+50 basis points per
quarter), parallel shift in interest rates. The change is measured from the net
interest income level that results from using the current yield curve. It is
estimated that net interest income would decline by 1.3% if rates were to
increase +200 basis points over the next year in a parallel shift from the
current yield curve.
EVE is defined as the discounted present value of asset cash flows and
derivative cash flows, minus the discounted value of liability cash flows. It
captures risk over the duration of the assets and liabilities. The timing and
variability of balance sheet cash flows are critical assumptions, along with
assumptions regarding the speed of loan and investment security prepayments and
the assumed behavior of non-maturity deposits. As of June 30, 2002, an immediate
increase of 100 and 200 basis points was estimated to reduce the EVE by 1.2% and
3.0%, respectively.
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. A large
portion of liquidity planning and management involves the level of core
deposits, which are comprised of non-interest bearing and interest bearing
demand deposits, savings accounts, and other domestic time deposits including
certificates of deposit under $100,000 and IRAs. Core deposits comprise 77% of
Huntington's funding needs. ALCO regularly monitors the overall liquidity
position of the business and ensures that various alternative strategies exist
to cover unanticipated events. Management believes sufficient liquidity was
available at the end of the recent quarter to meet estimated funding needs.
Funding sources other than core deposits include the sale or borrowings
against the investment securities portfolio, the securitization and sale of
loans, the ability to acquire national market non-core deposits, and the
issuance of notes and common and preferred securities in the capital markets.
30
The following table shows the composition of deposits by type of deposit
and by business segment, with the latter including a separate line indicating
deposits sold with the Florida banking operations in the first quarter of 2002:
The sale of the Florida operations required additional wholesale
borrowings of $1.2 billion, after receipt of the premium on deposits sold. To
help mitigate this funding, management activity grew core deposits over the last
twelve months to reduce its dependence on non-core funding. To further enhance
liquidity, Huntington initiated a $6 billion domestic bank note program in April
of 2002 to replace an older facility of the same size and expects to draw on
this note program in 2002.
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.
Shareholders' equity declined $82.1 million during the second quarter of
2002 from the end of the previous quarter and $64.6 million from December 31,
2001, but remained relatively flat compared to shareholders' equity at June 30,
2001. Comprehensive income for 2002 was more than offset by dividends of $79.0
million and repurchases of common shares of $175.2 million. Activity related to
shareholders' equity can be found on page 5 of this report. Average
shareholders' equity in the second quarter of 2002 declined a modest 1% from the
first quarter of 2002 and 2% from the second quarter of 2001.
31
Cash dividends that were declared in the second and four prior quarters
along with common stock prices (based on NASDAQ intra-day and closing stock
price quotes) were as follows:
The ratio of average equity to average assets in the second quarter of
2002 was 9.39% versus 9.54% a year ago. On a year to date basis, the ratio of
average equity to average assets was 9.47% and 9.52% for the first half of 2002
and 2001, respectively.
Tangible period-end equity to period-end assets, which excludes the
unrealized losses on securities available for sale and intangible assets, was
8.41% at the end of June 2002, up significantly from 5.97% a year earlier, but
down from 9.03% at the end of March 2002. The change in the tangible equity to
asset ratio from the year-ago periods reflected the capital generated from the
sale of the Florida operations and the subsequent share repurchase program in
the first and second quarters of 2002. Continuation of the share repurchase
program in the second half of 2002 at current repurchase levels will reduce the
ratio to 7.50% to 7.75% by year-end 2002. Management has previously indicated
its intent to maintain a minimum tangible equity to asset ratio of 6.50%
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, the leverage ratio,
and the risk-adjusted assets for the recent five quarters were as follows:
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.
In February 2002, the Board of Directors authorized a new share repurchase
program for up to 22 million shares and cancelled an earlier authorization.
Repurchased shares will be reserved for reissue in connection with dividend
reinvestment and employee benefit plans as well as for acquisitions and other
corporate purposes. Through the end of June 2002, approximately 8.8 million
shares of common stock had been repurchased through open market and privately
negotiated transactions.
LINES OF BUSINESS
Below is a brief description of each line of business and a discussion of
the business segment results. 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. Financial information and a full description of each line
of business can also be found in Note 8 to the unaudited consolidated financial
statements along with a reconciliation of reported earnings to operating
earnings.
32
Management reviews financial results on an operating basis, which excludes
the after-tax gain from the sale of the Florida operations, historical
results for Florida, and restructuring and special charges. The following tables
within each segment show performance on this basis for the three and six month
periods ending June 30, 2002 and 2001.
REGIONAL BANKING
Regional Banking provides products and services to retail, business
banking, and corporate customers.
Regional Banking operating income in the second quarter of 2002 was $22.3
million, down $22.9 million, or 51%, from the year-ago quarter. This decline
reflected higher provisions for loan losses as well as lower revenue (lower net
interest income and non-interest income), which was offset partially by reduced
expenses.
Net interest income was down $16.8 million, or 10%, reflecting a decline
in the internal funds credit for its deposits. Regional Banking is a net
funds provider to other business segments since its deposits exceed loans. As a
result, Regional Banking net interest income receives an internal funds transfer
pricing credit for these excess deposits. Conversely, those business segments
using these excess funds receive an internal funds transfer pricing charge. When
interest rates fall, as they have over the past year, net interest income in
Regional Banking is typically lower due to reduced credits attributed to
deposits.
Residential mortgage loans and home equity loans and lines each
increased 17% from the year-ago quarter with commercial real estate and
construction loans up 9% and 20%, respectively. Commercial loans, reflecting
the weakened economy as well as a specific effort to decrease exposure to
large shared national credits, declined 6% from the second quarter of 2001.
The provision for loan losses increased $20.5 million, almost double the
provision in the year-ago second quarter. This reflected the impact of higher
net charge-offs, as well as an increased provision for loan growth. Net
charge-offs in the second quarter of 2002 were $27.2 million, or an annualized
0.89% of average loans. This compared to $18.4 million, or 0.64% of loans in the
year-ago quarter. The increase in net charge-offs primarily reflected higher
commercial net charge-offs. (See page 27 for discussion of net charge-offs).
Non-interest income was down $5.5 million, or 7% from the second quarter
of last year, due to a decline in mortgage banking income. Mortgage banking
income declined 41% from the year-ago period due to a significant decline in
deliveries of loans to the secondary market and, to a lesser degree, a decision
to retain in the portfolio a higher percentage of originated residential
mortgage loans. Excluding the decline in mortgage banking income, non-interest
income in the second quarter of 2002 was up 2%.
Non-interest expense declined $7.5 million, or 5%. This reflected a 27%
decrease in equipment expense and a 4% decrease in occupancy expense, due to
lower depreciation and maintenance costs, as well as a 43% decline in
telecommunications expense. Partially offsetting these declines, were higher
professional expenses due to an increase in collection costs and higher outside
processing costs. Personnel costs were up only 1%.
Regional Banking contributed 63% of total revenues in the second quarter
of 2002 and represented 63% of total loans and 90% of total deposits at June 30,
2002.
DEALER SALES
Dealer Sales product offerings pertain to the automobile lending sector
and include indirect consumer loans and leases, as well as floor plan financing.
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Dealer Sales operating earnings were $20.0 million in the second quarter
of 2002, up $7.5 million, or 60%, from the year-ago quarter. This increase was
primarily driven by improved credit quality (which resulted in a decline in the
provision for loan losses) and to a lesser degree by higher revenue and lower
non-interest expense.
Net interest income in the second quarter of 2002 was $55.5 million, up
slightly from the year-ago quarter. Both the net interest margin and average
loans were up modestly when compared with the same period last year. The
provision for loan losses was $12.3 million in the second quarter of 2002, down
$8.7 million, or 41%, from the prior-year quarter reflecting the significant
reduction in auto-related net charge-offs. Auto loan and lease net charge-offs
in the second quarter of 2002 totaled $14.2 million, or 0.92% of average loans,
down from $15.8 million, or 1.03% of average loans, in the year-ago quarter.
This improvement reflected stronger underwriting practices for auto loan and
lease originations commencing in late 2000. Non-interest income was $5.9
million, up $2.0 million, or 52%, from the second quarter of 2001, which was
driven by higher securitization income. Non-interest expense remained relatively
flat for the comparable periods.
Dealer sales contributed 17% of total revenues in the second quarter of
2002 and represented 33% of total loans at the end of the recent quarter.
PRIVATE FINANCIAL GROUP
PFG provides an array of products and services designed to meet the needs
of Huntington's higher wealth customers.
Private Financial Group (PFG) operating earnings in the second quarter of
2002 were $7.9 million, up 158% from the year-ago quarter, primarily due to
substantially higher non-interest income. Non-interest income was $20.9 million,
up 86% from the year-ago quarter. This increase of $9.6 million resulted from
higher deposit account service charges, increased trust income due to the
acquisition of Haberer early in the second quarter 2002, and higher revenue from
sales of Huntington's proprietary mutual funds and annuities. Non-interest
expense increased $1.9 million, or 12%, from the year-ago quarter reflecting
increased sales commissions and other employee expenses associated with the rise
in non-interest income.
PFG contributed 8% of total revenues in the second quarter of 2002 and
represented 4% of total loans and 5% of total deposits at June 30, 2002.
TREASURY / OTHER
The Treasury / Other segment absorbs unassigned assets, liabilities,
equity, revenue, and expense that cannot be directly assigned or allocated to
one of the lines of business.
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Treasury / Other reported operating income of $31.6 million in the second
quarter of 2002, up from $14.9 million in the year-earlier quarter. This
primarily reflected the reduction in transfer pricing credits allocated to
Regional Banking for its deposits, the maturity in late 2001 of $2.0 billion of
interest rate risk management positions (swaps) that had significant negative
spreads, and the benefit of lower short-term interest rates, particularly with
the steepened yield curve.
Non-interest income declined $4.5 million from the year-ago quarter
reflecting the year-ago quarter's higher gains from securities transactions, due
to the sale of lower margin investment securities. Non-interest expense in the
second quarter of 2002 increased $3.8 million. This reflected higher unallocated
outside services and processing, occupancy, and telecommunication expenses,
partially offset by lower unallocated personnel costs and a $2.7 million
decline in the amortization of intangibles arising from the implementation of
SFAS No. 142.
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 is
lower. As a result, Treasury / Other reflects any reconciling items to the
statutory tax rate in its Income taxes.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosures for the current period are found
beginning on page 29 of this report, which includes changes in market risk
exposures from disclosures presented in Huntington's 2001 Annual Report.
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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 29, 2002. At that meeting, shareholders approved the following
management proposals:
Item 5. Other Information
On August 14, 2002, Huntington Preferred Capital, Inc. (HPCI), a fully
consolidated subsidiary of Huntington with a publicly traded class of preferred
securities, requested a five day extension for filing its Form 10-Q for the
quarter ending June 30, 2002, as permitted under the Securities Exchange Act of
1934. HPCI's Form 10-Q was otherwise due on August 14, 2002. The extension was
requested to allow for a complete analysis and correction of the systems and
methodology used to allocate financial information among Huntington's
subsidiaries prior to finalizing HPCI's second quarter Form 10-Q.
This allocation of income, expense and other financial information
among subsidiaries takes place after Huntington's consolidated financial
statements are prepared and reviewed. A preliminary review of the second quarter
2002 allocations indicated that interest income and certain charge-offs and
related provision expense were not fully allocated between The Huntington
National Bank (HNB) and HPCI. Further analysis has determined this discrepancy
has existed since October 1999. Indications are that when corrected, HPCI's
previously reported net income and equity will increase on a cumulative basis
over this period. Earnings coverage of the dividends on the public preferred
stock also will increase, thereby having no impact on HPCI's continued ability
to pay dividends.
Since HPCI and HNB are fully consolidated subsidiaries of Huntington,
any reallocation of financial information between these two subsidiaries has no
impact on Huntington's consolidated results of operations or financial
condition.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3. (ii) Amended and Restated Bylaws.
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
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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.
10. Material contracts:
(a)* Executive Deferred Compensation Plan for Huntington
Bancshares Incorporated.
99.1. Earnings to Fixed Charges
99.2 Chief Executive Officer Certification
99.3 Chief Financial Officer Certification
(b) Reports on Form 8-K
1. A report on Form 8-K, dated April 18, 2002, was filed under
report item numbers 5 and 7, concerning Huntington's results
of operations for the first quarter ended March 31, 2002.
* Denotes management contract or compensatory plan or arrangement.
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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, 2002 /s/ Thomas E. Hoaglin
--------------------------------------------
Thomas E. Hoaglin
Chairman, Chief Executive Officer and
President
Date: August 14, 2002 /s/ Michael J. McMennamin
--------------------------------------------
Michael J. McMennamin
Vice Chairman, Chief Financial Officer and
Treasurer (Principal Financial Officer)
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