Exhibit 13
SELECTED FINANCIAL DATA HUNTINGTON BANCSHARES INCORPORATED

Table 1 — Selected Financial Data

                                           
Year Ended December 31,

(in thousands of dollars, except per share amounts) 2004 2003 2002 2001 2000

 
Interest income
  $ 1,347,315     $ 1,305,756     $ 1,293,195     $ 1,654,789     $ 1,833,388  
 
Interest expense
    435,941       456,770       543,621       939,501       1,163,278  

Net interest income
    911,374       848,986       749,574       715,288       670,110  
 
Provision for credit losses
    55,062       163,993       194,426       257,326       61,464  

Net interest income after provision for credit losses
    856,312       684,993       555,148       457,962       608,646  

 
Operating lease income
    287,091       489,698       657,074       691,733       623,835  
 
Service charges on deposit accounts
    171,115       167,840       153,564       165,012       161,426  
 
Securities gains
    15,763       5,258       4,902       723       37,101  
 
Gain on sales of automobile loans
    14,206       40,039                    
 
Gain on sale of branch offices
          13,112                    
 
Gain on sale of Florida operations
                182,470              
 
Merchant Services gain
                24,550              
 
Other non-interest income
    330,423       353,206       319,144       342,474       300,840  

Total non-interest income
    818,598       1,069,153       1,341,704       1,199,942       1,123,202  

 
Personnel costs
    485,806       447,263       418,037       454,210       396,230  
 
Operating lease expense
    236,478       393,270       518,970       558,626       494,800  
 
Restructuring reserve (releases) charges
    (1,151 )     (6,666 )     48,973       79,957          
 
Loss on early extinguishment of debt
          15,250                    
 
Other non-interest expense
    401,111       381,042       388,167       469,634       392,101  

Total non-interest expense
    1,122,244       1,230,159       1,374,147       1,562,427       1,283,131  

Income before income taxes
    552,666       523,987       522,705       95,477       448,717  
 
Provision (benefit) for income taxes
    153,741       138,294       198,974       (39,319 ) (6)     126,299  

Income before cumulative effect of change in accounting principle
    398,925       385,693       323,731       134,796       322,418  
Cumulative effect of change in accounting principle, net of tax(1)
          (13,330 )                  

Net income
  $ 398,925     $ 372,363     $ 323,731     $ 134,796     $ 322,418  

Income before cumulative effect of change in accounting
principle per common share — basic
    $1.74       $1.68       $1.34       $0.54       $1.30  
Net Income per common share — basic
    1.74       1.62       1.34       0.54       1.30  
Income before cumulative effect of change in accounting principle per common share — diluted
    1.71       1.67       1.33       0.54       1.29  
Net Income per common share — diluted
    1.71       1.61       1.33       0.54       1.29  
Cash dividends declared
    0.75       0.67       0.64       0.72       0.76  
 
Balance sheet highlights
                                       

Total assets (period end)(2)
  $ 32,565,497     $ 30,519,326     $ 27,539,753     $ 28,458,769     $ 28,534,567  
Total long-term debt (period end)(3)
    6,326,885       6,807,979       4,246,801       2,739,332       3,388,126  
Total shareholders’ equity (period end)
    2,537,638       2,275,002       2,189,793       2,341,897       2,335,229  
Average long-term debt(3)
    6,650,367       5,816,660       3,613,527       3,429,480       4,017,584  
Average shareholders’ equity
    2,374,137       2,196,348       2,238,761       2,330,968       2,191,788  
Average total assets(2)
    31,432,746       28,971,701       26,063,281       28,126,386       28,589,244  
 
Key ratios and statistics
                                       

Margin analysis — as a % of average earnings assets
                                       
 
Interest income(4)
    4.89 %     5.35 %     6.23 %     7.58 %     8.13 %
 
Interest expense
    1.56       1.86       2.61       4.29       5.13  

Net interest margin(4)
    3.33 %     3.49 %     3.62 %     3.29 %     3.00 %

Return on average total assets
    1.27 %     1.29 %     1.24 %     0.48 %     1.13 %
Return on average total shareholders’ equity
    16.8       17.0       14.5       5.8       14.7  
Efficiency ratio(5)
    65.0       63.9       65.6       79.2       70.5  
Dividend payout ratio
    43.9       41.6       48.1       133.3       58.9  
Average shareholders’ equity to average assets(2)
    7.55       7.58       8.59       8.29       7.67  
Effective tax rate
    27.8       26.4       38.1       (41.2 )(6)     28.1  
Tangible equity to asset (period end)(7)
    7.18       6.79       7.22       5.86       5.69  
Tier 1 leverage ratio
    8.42       7.98       8.51       7.16       6.85  
Tier 1 risk-based capital ratio (period end)
    9.08       8.53       8.34       7.02       7.13  
Total risk-based capital ratio (period end)
    12.48       11.95       11.25       10.07       10.29  
 
Other data
                                       

Full-time equivalent employees
    7,812       7,983       8,177       9,743       9,693  
Domestic banking offices
    342       338       343       481       508  

(1)  Due to the adoption of FASB Interpretation No. 46 for variable interest entities.
 
(2)  Period end total assets and average total assets were restated for prior periods due to the reclass of “Allowance for Unfunded Commitments and LOC”, from Allowance for loan and lease losses to the liability section of the balance sheet.
 
(3)  Includes Federal Home Loan Bank advances, other long-term debt, and subordinated notes.
 
(4)  On a fully taxable equivalent (FTE) basis assuming a 35% tax rate.
 
(5)  Non-interest expense less amortization of intangibles divided by the sum of FTE net interest income and non-interest income excluding securities gains.
 
(6)  Reflects a $32.5 million reduction related to the issuance of $400 million REIT subsidiary preferred stock, of which $50 million was sold to the public.
 
(7)  Total equity minus intangible assets divided by total assets minus intangible assets.

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION HUNTINGTON BANCSHARES INCORPORATED

AND RESULTS OF OPERATIONS

INTRODUCTION

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

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

The reader should note the following discussion is divided into key segments:

  –  INTRODUCTION — Provides overview comments on important matters including risk factors, the Securities and Exchange Commission (SEC) investigation and banking regulatory agreements, and critical accounting policies and use of significant estimates. These are essential for understanding the Company’s performance and prospects.
 
  –  DISCUSSION OF RESULTS — Reviews financial performance from a consolidated perspective. It also includes a Significant Factors Influencing Financial Performance Comparisons section that summarizes key issues important for a complete understanding of performance trends. Key consolidated balance sheet and income statement trends are discussed in this section.
 
  –  RISK MANAGEMENT — Discusses credit and market risks, including how these risks are managed, as well as performance trends. It also includes a discussion of liquidity policies, how funding is managed, and related performance. In addition, there is a discussion of guarantees and/or commitments made for items such as standby letters of credit and commitments to sell loans, and a discussion that reviews the adequacy of capital including regulatory classifications.
 
  –  LINES OF BUSINESS DISCUSSION — Provides an overview of financial performance for each major line of business and provides additional discussion of trends underlying consolidated financial performance.
 
  –  RESULTS FOR THE FOURTH QUARTER — Provides a discussion of results for the 2004 fourth quarter compared with the year-earlier quarter.

A reading of each section is important for investors and others to achieve a full understanding of the nature of the Company’s financial performance and prospects.

Forward-Looking Statements

This report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements about Huntington. These include descriptions of products or services, plans or objectives of Management for future operations, including any pending acquisitions, and forecasts of revenues, earnings, cash flows, or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.

By their nature, forward-looking statements are subject to numerous assumptions, risks, and uncertainties. A number of factors could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to, those set forth under the heading “Business Risks” included in Item 1 of Huntington’s Annual Report on Form 10-K for the year ended December 31, 2004, and other factors described in this report and from time-to-time in other filings with the SEC.

Management encourages readers of this report to understand forward-looking statements to be strategic objectives rather than absolute forecasts of future performance. Forward-looking statements speak only as of the date they are made. Huntington assumes no obligation to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements were made or to reflect the occurrence of unanticipated events.

Risk Factors

Huntington, like other financial companies, is subject to a number of risks, many of which are outside of Management’s control, though efforts are made to manage those risks while optimizing returns. Among the risks assumed are: (1) credit risk, which is the

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

risk that loan and lease customers or other counter parties will be unable to perform their contractual obligations, (2) market risk, which is the risk that changes in market rates and prices will adversely affect Huntington’s financial condition or results of operation, (3) liquidity risk, which is the risk that Huntington and / or the Bank will have insufficient cash or access to cash to meet operating needs, and (4) operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. More information on risk is set forth under the heading “Business Risks” included in Item 1 of Huntington’s Annual Report on Form 10-K for the year ended December 31, 2004. The description of Huntington’s business contained in Item 1 of its Annual Report on Form 10-K, while not all-inclusive, discusses a number of business risks that, in addition to the other information in this report, readers should carefully consider.

Securities and Exchange Commission Formal Investigation and Formal Regulatory Supervisory Agreements

SEC FORMAL INVESTIGATION

On June 26, 2003, Huntington announced that the Securities and Exchange Commission (SEC) staff was conducting a formal investigation into certain financial accounting matters relating to fiscal years 2002 and earlier and certain related disclosure matters. On August 9, 2004, Huntington announced the Company was in negotiations with the staff of the SEC regarding a settlement of the formal investigation and disclosed that it expected that a settlement of this matter, which is subject to approval by the SEC, would involve the entry of an order requiring, among other possible matters, Huntington to comply with various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933, along with the imposition of a civil money penalty. At December 31, 2004, the Company had reserves related to the expectation of the imposition of a civil money penalty, which the Company viewed as sufficient given negotiations with the SEC. However, no assurances can be made that any assessed penalty may not exceed this amount.

Management continues to have ongoing discussions with the staff of the SEC regarding resolution of this matter. The final results of the investigation, however, are not known at the time of this filing and therefore, the impact to Huntington’s financial condition, results of operations, and cash flows is not known.

FORMAL REGULATORY SUPERVISORY AGREEMENTS

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

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

Critical Accounting Policies and Use of Significant Estimates

Huntington’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of financial statements in conformity with GAAP requires Management to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in its financial statements. Note 1 of the Notes to Consolidated Financial Statements included in this report lists significant accounting policies used by Management in the development and presentation of Huntington’s financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of the organization and its financial position, results of operations, and cash flows.

An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements if a different amount within a range of estimates were used or if estimates changed from period-to-period. Readers of this report should understand that estimates are made under facts and circumstances at a point in time, and changes in those facts and circumstances could produce actual results that differ from when those estimates were made. Management has identified the following as the most significant accounting estimates and their related application. This analysis is included to emphasize that estimates are used in connection with the critical and other accounting policies and to illustrate the potential effect on the financial statements if the actual amount were different from the estimated amount.

–  TOTAL ALLOWANCES FOR CREDIT LOSSES — At December 31, 2004, the allowances for credit losses (ACL) totaled $304.4 million and represented the sum of the allowance for loan and lease losses (ALLL) and the allowance for unfunded loan commitments and

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

letters of credit (AULC). The determination of the amount of the ACL is based on Management’s current judgments regarding the quality of the loan portfolio, and considers all known relevant internal and external factors that affect loan collectibility. The ACL represents Management’s estimate as to the level of reserves appropriate to absorb probable inherent credit losses in the loan and lease portfolio, as well as unfunded loan commitments. Management believes the process for determining the ACL considers all of the potential factors that could result in credit losses. However, the process includes judgmental and quantitative elements that may be subject to significant change. To the extent actual outcomes differ from Management estimates, additional provision for credit losses could be required, which could adversely affect earnings or financial performance in future periods. At December 31, 2004, the ACL as a percent of total loans and leases was 1.29%. Based on the December 31, 2004 balance sheet, a 10 basis point increase in this ratio to 1.39% would require $23.6 million in additional reserves (funded by additional provision for credit losses), which would have negatively impacted 2004 net income by approximately $15.3 million or $0.07 per share. A discussion about the process used to estimate the ACL is presented in the Credit Risk section of Management’s Discussion and Analysis in this report.

–  MORTGAGE LOAN SERVICING RIGHTS — At December 31, 2004, there were $77.1 million of mortgage servicing rights included in other assets. No active market exists with observable market prices for these financial instruments. To estimate fair values, Management estimates future prepayments on the loans serviced for others, future ancillary revenue, future costs to service these assets, adequate compensation for servicing the loans, and the appropriate discount rate to use. Note 5 of the Notes to Consolidated Financial Statements contains an analysis of the impact to the fair value of mortgage servicing rights resulting from changes in the estimates used by Management. A discussion about the process used to estimate the fair value of mortgage servicing rights is presented in the Non-Interest Income section of Management’s Discussion and Analysis in this report.
 
At December 31, 2004, the assumptions and the sensitivity of the current fair value of the Huntington’s mortgage servicing rights to immediate 10% and 20% adverse changes in those assumptions were:

                         
Pre-tax decline in
fair value due to

10%
adverse 20%
(in millions of dollars) Actual change adverse

Constant pre-payment rate
    21.70 %   $ (4.8 )   $ (9.1 )
Discount rate
    8.85       (2.2 )     (4.2 )

–  LEASE RESIDUAL VALUES UNDERLYING OPERATING LEASES — At December 31, 2004, a total of $403.4 million of its investment in vehicles under operating leases represented Management’s estimate of the aggregate of each vehicle’s residual value, which is the predicted value of the vehicle at the end of the lease term. The Company depreciates the vehicles it leases under operating lease accounting to this residual value. The depreciation is recognized on a straight-line basis over the life of the lease. On a quarterly basis, Management reviews the expected future residual value losses for leased automobiles taking into consideration the insurance policy caps on insured losses. As a result of that review, Management determines how much impairment, if any, needs to be recognized on these operating leases and whether the residual value should be adjusted prospectively. When the estimate of this residual value declines, the Company increases its rate of depreciation to depreciate the vehicle to the new estimated residual value by the end of the lease term.

    To manage this risk, the Company purchased residual value insurance. The Company currently has one insurance policy in effect, covering operating leases originated between October 2000 and April 2002. This policy covers $298.0 million of residual values but has a $50 million cap on losses that it will cover. Based on current vehicle values, Management estimates total claims against this policy will be $11-$25 million, well below the cap. A total of $105.1 million of residual values relate to originations prior to October 2000 and are no longer covered by insurance. The insurance policy covering the residual values of these leases had a $120 million cap and claims under that policy have exceeded this cap. Management estimates that future losses from this portfolio could be $17-$28 million, of which $10 million has already been recognized through additional depreciation. Further discussion about the process used to estimate the risk of residual value losses on operating leases is presented in the Market Risk and Operating Lease Assets sections of Management’s Discussion and Analysis in this report. Notes 1 and 7 of the Notes to Consolidated Financial Statements included in this report explain the accounting for operating lease assets in more detail.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Table 2 — Selected Annual Income Statements

                                                                           
Year Ended December 31,

Change from 2003 Change from 2002


(in thousands, except per share amounts) 2004 Amount % 2003 Amount % 2002 2001 2000

 
Interest income
  $ 1,347,315     $ 41,559       3.2 %   $ 1,305,756     $ 12,561       1.0 %   $ 1,293,195     $ 1,654,789     $ 1,833,388  
 
Interest expense
    435,941       (20,829 )     (4.6 )     456,770       (86,851 )     (16.0 )     543,621       939,501       1,163,278  

Net interest income
    911,374       62,388       7.3       848,986       99,412       13.3       749,574       715,288       670,110  
 
Provision for credit losses
    55,062       (108,931 )     (66.4 )     163,993       (30,433 )     (15.7 )     194,426       257,326       61,464  

Net interest income after provision for credit losses
    856,312       171,319       25.0       684,993       129,845       23.4       555,148       457,962       608,646  

 
Operating lease income
    287,091       (202,607 )     (41.4 )     489,698       (167,376 )     (25.5 )     657,074       691,733       623,835  
 
Service charges on deposit accounts
    171,115       3,275       2.0       167,840       14,276       9.3       153,564       165,012       161,426  
 
Trust services
    67,410       5,761       9.3       61,649       (402 )     (0.6 )     62,051       60,298       53,613  
 
Brokerage and insurance income
    54,799       (3,045 )     (5.3 )     57,844       (4,265 )     (6.9 )     62,109       75,013       60,530  
 
Bank owned life insurance income
    42,297       (731 )     (1.7 )     43,028       (95 )     (0.2 )     43,123       41,123       39,544  
 
Other service charges and fees
    41,574       128       0.3       41,446       (1,442 )     (3.4 )     42,888       48,217       43,883  
 
Mortgage banking
    32,296       (25,884 )     (44.5 )     58,180       26,147       81.6       32,033       54,518       32,772  
 
Securities gains
    15,763       10,505       N.M.       5,258       356       7.3       4,902       723       37,101  
 
Gain on sales of automobile loans
    14,206       (25,833 )     (64.5 )     40,039       40,039       N.M.                    
 
Gain on sale of branch offices
          (13,112 )     N.M.       13,112       13,112       N.M.                    
 
Gain on sale of Florida operations
                            (182,470 )     N.M.       182,470              
 
Merchant services gain
                            (24,550 )     N.M.       24,550              
 
Other
    92,047       988       1.1       91,059       14,119       18.4       76,940       63,305       70,498  

Total non-interest income
    818,598       (250,555 )     (23.4 )     1,069,153       (272,551 )     (20.3 )     1,341,704       1,199,942       1,123,202  

 
Personnel costs
    485,806       38,543       8.6       447,263       29,226       7.0       418,037       454,210       396,230  
 
Operating lease expense
    236,478       (156,792 )     (39.9 )     393,270       (125,700 )     (24.2 )     518,970       558,626       494,800  
 
Net occupancy
    75,941       13,460       21.5       62,481       2,942       4.9       59,539       76,449       75,197  
 
Outside data processing and other services
    72,115       5,997       9.1       66,118       (1,250 )     (1.9 )     67,368       69,692       62,011  
 
Equipment
    63,342       (2,579 )     (3.9 )     65,921       (2,402 )     (3.5 )     68,323       80,560       78,069  
 
Professional services
    36,876       (5,572 )     (13.1 )     42,448       9,363       28.3       33,085       32,862       22,721  
 
Marketing
    26,489       (1,001 )     (3.6 )     27,490       (421 )     (1.5 )     27,911       31,057       34,884  
 
Telecommunications
    19,787       (2,192 )     (10.0 )     21,979       (682 )     (3.0 )     22,661       27,984       26,225  
 
Printing and supplies
    12,463       (546 )     (4.2 )     13,009       (2,189 )     (14.4 )     15,198       18,367       19,634  
 
Amortization of intangibles
    817       1       0.1       816       (1,203 )     (59.6 )     2,019       41,225       39,207  
 
Restructuring reserve (releases) charges
    (1,151 )     5,515       (82.7 )     (6,666 )     (55,639 )     N.M.       48,973       79,957        
 
Loss on early extinguishment of debt
          (15,250 )     N.M.       15,250       15,250       N.M.                    
 
Other
    93,281       12,501       15.5       80,780       (11,283 )     (12.3 )     92,063       91,438       34,153  

Total non-interest expense
    1,122,244       (107,915 )     (8.8 )     1,230,159       (143,988 )     (10.5 )     1,374,147       1,562,427       1,283,131  

Income before income taxes
    552,666       28,679       5.5       523,987       1,282       0.2       522,705       95,477       448,717  
 
Provision (benefit) for income taxes (3)
    153,741       15,447       11.2       138,294       (60,680 )     (30.5 )     198,974       (39,319 )     126,299  

Income before cumulative effect of change in accounting principle
    398,925       13,232       3.4       385,693       61,962       19.1       323,731       134,796       322,418  
Cumulative effect of change in accounting principle, net of tax(1)
          13,330       N.M.       (13,330 )     (13,330 )     N.M.                    

Net income
  $ 398,925     $ 26,562       7.1 %   $ 372,363     $ 48,632       15.0 %   $ 323,731     $ 134,796     $ 322,418  

Average common shares — basic
    229,913       512       0.2 %     229,401       (12,878 )     (5.3 )%     242,279       251,078       248,709  
Average common shares — diluted
    233,856       2,274       1.0       231,582       (12,430 )     (5.1 )     244,012       251,716       249,570  
 
Per common share:
                                                                       
 
Income before cumulative effect of change in accounting principle — basic
    $1.74       $0.06       3.6 %     $1.68       $0.34       25.4 %     $1.34       $0.54       $1.30  
 
Net income — basic
    1.74       0.12       7.4       1.62       0.28       20.9       1.34       0.54       1.30  
 
 
Income before cumulative effect of change in accounting principle — diluted
    1.71       0.04       2.4       1.67       0.34       25.6       1.33       0.54       1.29  
 
Net income — diluted
    1.71       0.10       6.2       1.61       0.28       21.1       1.33       0.54       1.29  
 
 
Cash dividends declared
    0.75       0.08       11.9       0.67       0.03       4.7       0.64       0.72       0.76  
 
Net interest income — fully taxable equivalent — FTE
                                                                       
Net interest income
  $ 911,374     $ 62,388       7.3 %   $ 848,986     $ 99,412       13.3 %   $ 749,574     $ 715,288     $ 670,110  
Tax equivalent adjustment (2)
    11,653       1,969       20.3       9,684       4,479       86.1       5,205       6,352       8,310  

Net interest income — FTE
  $ 923,027     $ 64,357       7.5 %   $ 858,670     $ 103,891       13.8 %   $ 754,779     $ 721,640     $ 678,420  

N.M., not a meaningful value.

(1)  Due to adoption of FASB Interpretation No. 46 for variable interest entities.
 
(2)  Calculated assuming a 35% tax rate.
 
(3)  2001 reflects a $32.5 million reduction related to the insurance of $400 million REIT subsidiary preferred stock, of which $50 million was sold to the public.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

DISCUSSION OF RESULTS

This section provides a review of financial performance from a consolidated perspective. It also includes a Significant Factors Influencing Financial Performance Comparisons section that summarizes key issues important for a complete understanding of performance trends. Key consolidated balance sheet and income statement trends are discussed in this section. All earnings per share data is reported on a diluted basis. For additional insight on financial performance, this section should be read in conjunction with the Lines of Business discussion.

Summary

Huntington reported net income in 2004 of $398.9 million, or $1.71 per common share, up 7% and 6%, respectively, from 2003. Earnings in 2003 were $372.4 million, or $1.61 per common share, up from $323.7 million, or $1.33 per common share, in 2002. The returns on average total shareholders’ equity (ROE) for 2004, 2003, and 2002 were 16.8%, 17.0%, and 14.5%, respectively, with returns on average total assets (ROA) of 1.27%, 1.29%, and 1.24%, respectively. (See Tables 1 and 2.)

The period from 2001 to 2004 was one of significant transformation for the Company. During 2001, Management initiated a comprehensive strategic refocusing plan to improve competitiveness and long-term financial performance, which influenced results throughout this period. Actions taken included hiring new executive and other managerial leadership, changing the basic business model to one of local decision-making and refocusing on Midwest markets, as well as other activities such as reducing the overall credit risk profile and improving credit quality performance, all with the objective of improving overall financial performance. In 2001, the quarterly common stock dividend was reduced 20%, but reflecting the sufficient progress made, the dividend was increased 9% in 2003, and then another 14% in 2004, which restored the quarterly dividend to the level prior to the 2001 reduction. In 2003, a formal investigation was initiated by the SEC, which awaits resolution. (See the Significant Factors Influencing Financial Performance Comparisons section for a full discussion of the financial impact of strategic initiatives and other factors influencing financial performance and comparisons of financial results between reporting periods, as well as the SEC Formal Investigation and Formal Regulatory Supervisory Agreements sections.)

Earnings per common share in 2002 were $1.33, up from $0.54 in 2001. Earnings in 2002 were impacted by the completion of the sale of the Florida banking operations and restructuring of the Company’s Merchant Services business, both of which resulted in significant gains. Capital from these gains was used to repurchase 9% of common shares outstanding and to invest in a number of activities including improvements in customer service technology and the purchases of a small money management firm and a niche equipment leasing company. The Florida insurance operation was also sold, though this had no significant earnings impact. However, earnings were negatively impacted by additional restructuring charges as the 2001 strategic initiatives continued to be implemented. Average loans and deposits declined 4% and 11%, respectively, reflecting the impact of the sold Florida banking operations. The net interest margin declined during the second half of the year, reflecting a significant reduction in market interest rates, as interest rates on earning assets, both loans and investment securities, declined more rapidly than deposit rates. The yield on mortgage-backed securities declined sharply as the lower level of interest rates resulted in higher prepayments on the underlying mortgages, with the resultant cash flow reinvested in lower-yielding earning assets. Earnings benefited by a reduction in the provision for credit losses as the level of non-performing assets (NPAs) at year end declined 40% from the end of 2001.

Earnings per common share in 2003 were $1.61, up 21% from $1.33 reported for the prior year. Earnings benefited by growth in average loans and deposits of 15% and 6%, respectively. This benefit was partially offset by a decline in the net interest margin reflecting the continuation of pressure on the net interest margin and specifically, mortgage-related earning asset yields, as interest rates continued to decline through mid-year. Some of this pressure was relieved in the second half of the year as interest rates increased. Late in the year, a portion of high cost, long-term debt was repaid. This resulted in a charge to earnings, but lowered funding costs in future periods. In addition, 2003 reflected the release of certain restructuring reserves as the costs of implementing the strategic decisions made in 2001, and carried out through 2002 and 2003, were completed. The provision for credit losses declined as credit quality trends improved significantly. Loan concentrations continued to be lowered, aided by the sales of automobile loans and under-performing middle market commercial and industrial (C&I) and middle market commercial real estate (CRE) loans, including NPAs, among other strategies. NPAs ended the year near the lowest level in many years.

Earnings per common share in 2004 were $1.71, up 6% from $1.61 reported for the prior year. Earnings again benefited from strong growth in average loans and deposits of 11% and 7%, respectively. Once more, this benefit was partially offset by a decline in the net interest margin reflecting the continuation of overall declines in interest rates during the first half of the year, though there were periods of interest rate volatility. Importantly, the net interest margin stabilized in the second half of the year, such that more of the positive impact of loan growth in that period resulted in net interest income growth. A reduction in loan loss provision expense significantly benefited earnings. This reflected the maintenance of strong credit quality performance, as well as improved credit quality trends due to the continued reduction in the concentration of higher-risk loans and increase in lower-risk residential mortgages and

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

home equity loans. It also reflected an improved economic outlook that resulted in a reduction in the relative level of the ALLL. Among other factors that impacted earnings negatively, were SEC-related expenses and accruals, as well as a property lease impairment in the fourth quarter of the year.

Results of Operations

Significant Factors Influencing Financial Performance Comparisons

Earnings comparisons among the three years ended December 31, 2004, are impacted by a number of factors, some related to changes in the economic and competitive environment, while others reflected specific Management strategies or changes in accounting practices. Those key factors are summarized below.

    1.  AUTOMOBILE LEASES ORIGINATED BEFORE MAY 2002 ARE ACCOUNTED FOR AS OPERATING LEASES — Automobile leases originated before May 2002 are accounted for using the operating lease method of accounting because they do not qualify as direct financing leases. Operating leases are carried in other assets with the related rental income, other revenue, and credit recoveries reflected as operating lease income, a component of non-interest income. Under this accounting method, depreciation expenses, as well as other costs and charge-offs, are reflected as operating lease expense, a component of non-interest expense. With no new operating leases originated since April 2002, the operating lease assets have declined rapidly and will eventually become immaterial, as will the related operating lease income and expense. However, since operating lease income and expense represented a significant percentage of total non-interest income and expense, respectively, throughout these reporting periods, their downward trend influenced total non-interest income and non-interest expense trends.

    In contrast, automobile leases originated since April 2002 are accounted for as direct financing leases, an interest-bearing asset included in total loans and leases with the related income reflected as interest income and included in the calculation of the net interest margin. Credit charge-offs and recoveries are reflected in the ALLL, with related changes in the ALLL reflected in provision for credit losses. The relative newness and rapid growth of the direct financing lease portfolio has resulted in higher reported automobile lease growth rates than in a more mature portfolio. To better understand overall trends in automobile lease exposure, it is helpful to compare trends in the combined total of direct financing leases plus operating leases. (See Table 6.)

    2.  TRANSITION FROM A WEAK ECONOMIC ENVIRONMENT IN 2002 AND 2003 TO A SLOWLY RECOVERING ECONOMIC ENVIRONMENT IN 2004 — While difficult to quantify, Management believes the weak economic environment resulted in continued weak demand for C&I loans. This, when combined with strategies to lower the overall credit risk profile of the Company (see Factor 4 below), contributed to generally declining C&I loans throughout this period until the second half of 2004.
 
    3.  DECLINING INTEREST RATES IN 2002 AND 2003 WITH GENERALLY INCREASING, THOUGH FLUCTUATING, INTEREST RATES IN 2004 — Interest rates impacted, among other factors, loan and deposit growth, the net interest margin, and the valuation of mortgage servicing rights (MSRs) and investment securities.

  –  The historically low interest rate environment of the last three years, despite a general increase in short-term rates during 2004, resulted in strong demand and growth in residential real estate, home equity, and CRE loans throughout this period. Mortgage banking revenue was also favorably impacted by significant mortgage origination activity most notably in 2003.
 
  –  As interest rates fell in 2003 to historically low levels, it became increasingly difficult to lower interest rates offered on deposit accounts commensurate with the overall decline in yields on earning assets. This created an extremely competitive environment in which to grow deposits and contributed to the decline in the net interest margin throughout 2003. Though short-term interest rates increased generally throughout 2004, they nevertheless remained at historically low levels, and the market for deposits remained very competitive. As a result, deposit rates in 2004 increased thus dampening the expansion in the net interest margin.
 
  –  Since the second quarter of 2002, the Company generally has retained the servicing on mortgage loans it originates and sells in the secondary market. This servicing asset, referred to as an MSR, is an interest only strip. Huntington is typically paid 0.25%-0.35% of the loan balance to service the loans. The MSR represents the present value of expected future net servicing income for the loan. The MSR asset is valued quarterly at the lower of cost or market, with impairment of the asset, or recovery of prior temporary impairment, recorded in mortgage banking income. Expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly reduced by prepayments. Prepayments usually increase when mortgage interest rates decline and decrease

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

  when mortgage interest rates rise. Thus, as interest rates decline, less future income is expected and the value of MSRs decreases and results in an MSR temporary impairment when the valuation is less than the recorded book value. Should interest rates rise, the opposite may happen; i.e. prepayments slow and the value of the MSR increases, which may result in an MSR temporary impairment recovery. The Company recognizes any temporary impairments or recoveries through a valuation reserve, but records a direct write-down of the book value of its MSRs for other-than-temporary declines in valuation. Changes and fluctuations in interest rate levels between periods resulted in some periods reporting an MSR temporary impairment, with others reporting recoveries. Such swings in MSR valuations have significantly impacted mortgage banking income throughout this period. (See Tables 3 and 8.)
 
  –  The Company uses gains or losses on investment securities, and beginning in 2004 gains or losses and net interest income on trading account assets, to offset MSR temporary valuation changes. Valuation of trading and investment securities generally react to interest rate changes in an opposite direction compared with MSR valuations. However, such valuation changes are not always of the same magnitude. As a result, changes in interest rate levels that impacted MSR valuations also resulted in securities or trading gains or losses. As such, in quarters where an MSR temporary impairment is recognized, investment securities and/or trading account assets were sold resulting in a gain on sale, and vice versa. Investment securities gains or losses are reflected in the income statement in a single non-interest income line item, whereas trading gains or losses are a component of other non-interest income on the income statement. The earnings impact of the MSR valuation change and the combination of securities and/or trading gains/losses may not exactly offset due to, among other factors, the difference in the timing of when the MSR valuation is determined and recorded, compared with when the securities are sold and any gain or loss is recorded. (See Table 3.)

    4.  MANAGEMENT STRATEGIES TO LOWER THE OVERALL CREDIT RISK PROFILE OF THE BALANCE SHEET — Throughout this period, certain strategies were implemented to lower the overall credit risk profile of the loan portfolio with the objective of lowering the volatility of earnings.

  –  Automobile Loan Sales

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

  –  Reduction in Large Individual C&I and CRE Credits

  This strategy resulted in the reduction of shared national credits, as well as other, mostly C&I, loans. In addition, the Company sold and charged-off lower-quality C&I and CRE credits in 2003 and 2004. This strategy was a contributing factor in the declines in C&I loan balances, NPAs, and the ALLL. In certain periods, this strategy contributed to higher C&I net charge-offs.

    5.  ADOPTION OF FIN 46 — Effective July 1, 2003, the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. The adoption of FIN 46 resulted in the consolidation of $1.0 billion of securitized automobile loans and a $13.3 million after-tax charge in the 2003 third quarter for the cumulative effect of a change in accounting principle. (See Tables 1, 2 and 3.)
 
    6.  SALE OF FLORIDA BANKING AND INSURANCE OPERATIONS AND MERCHANT SERVICES RESTRUCTURING — In February 2002, the Company completed the sale of its Florida banking operations. This resulted in a $182.5 million gain being recorded in non-interest income. The Florida banking operations sale eliminated $2.8 billion of loans and $4.8 billion of deposits from the 2002 balance sheet, thus affecting related comparisons with 2003. The Company also completed the sale of its Florida insurance operations in the 2002 second quarter, with no significant earnings impact. Combined, the Florida banking and insurance operations reported a net loss from operations of $1.5 million in 2002. In addition, in 2002, the Company restructured its interest in Huntington Merchant Services, L.L.C. (HMS), which resulted in a $24.6 million gain being recorded to non-interest income. (See Table 3 and Note 27 of the Notes to Consolidated Financial Statements.)
 
    7.  CORPORATE RESTRUCTURING CHARGES (RELEASES) — The 2001 strategic refocusing plan included the intent to sell the Florida banking and insurance operations, credit-related and other actions to strengthen the balance sheet and financial performance, and the consolidation of numerous non-Florida banking offices. As a result, non-interest expense in 2002 was higher than it otherwise would have been, as it included net restructuring charges of $49.0 million based on estimated costs associated with implementing these strategic initiatives. In contrast, 2003 and 2004 non-interest expense reflected releases of

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

  $6.7 million and $1.2 million, respectively, of previously established reserves, which were no longer needed, and which lowered 2003 and 2004 non-interest expense. (See Table 3 and Note 26 of the Notes to Consolidated Financial Statements.)

    8.  SINGLE COMMERCIAL RECOVERY — A single commercial credit recovery of $11.1 million in 2004 on a loan previously charged-off in 2002 favorably impacted the 2004 loan loss provision expense, as well as C&I, total commercial, and total net charge-offs for the year. (See Tables 3 and 16.)
 
    9.  GAIN ON THE SALE OF WEST VIRGINIA BANKING OFFICES — In the 2003 third quarter, the Company sold four banking offices in West Virginia, which resulted in a $13.1 million gain. (See Tables 1, 2 and 3.)

  10.  SEC FORMAL INVESTIGATION-RELATED EXPENSES AND ACCRUALS — On June 26, 2003, Huntington announced that the Securities and Exchange Commission (SEC) staff was conducting a formal investigation into certain financial accounting matters relating to fiscal years 2002 and earlier and certain related disclosure matters. On August 9, 2004, Huntington announced the Company was in negotiations with the staff of the SEC regarding a settlement of the formal investigation and disclosed that it expected that a settlement of this matter, which is subject to approval by the SEC, would involve the entry of an order requiring, among other possible matters, Huntington to comply with various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933, along with the imposition of a civil money penalty. At December 31, 2004, the Company had reserves related to the expectation of the imposition of a civil money penalty, which the Company viewed as sufficient given negotiations with the SEC. However, no assurances can be made that any assessed penalty may not exceed this amount.

Management continues to have ongoing discussions with the staff of the SEC regarding resolution of this matter. The final results of the investigation, however, are not known at the time of this filing and therefore, the impact to Huntington’s financial condition, results of operations, and cash flows is not known.
 
In connection with this investigation, $13.6 million of expenses and accruals were recorded in 2004, following $6.9 million of such costs in 2003. (See Table 3 and Note 22 of the Notes to Consolidated Financial Statements.)

  11.  UNIZAN ACQUISITION SYSTEM CONVERSION EXPENSES — On January 27, 2004, Huntington announced the signing of a definitive agreement to acquire Unizan Financial Corp. (Unizan), a financial holding company based in Canton, Ohio. On June 16, 2004, Huntington announced that the closing of the Unizan merger would be delayed beyond the early July 2004 targeted date as the FRBC had informed the Company it was extending its merger application review period to coordinate further with the staff of the SEC regarding the SEC’s formal investigation and to complete its review of the Community Reinvestment Act aspects of the merger. On November 3, 2004, Huntington announced that it was negotiating a one-year extension of its pending merger agreement with Unizan. It was also announced that Huntington was withdrawing its current application with the FRBC to acquire Unizan and intends to resubmit the application for regulatory approval of the merger once Huntington has successfully resolved the pending SEC and banking regulatory concerns. On November 11, 2004, Huntington and Unizan jointly announced they had entered into an amendment to their January 26, 2004 merger agreement. The amendment extends the term of the agreement for one year from January 27, 2005 to January 27, 2006.

Management remains in active dialogue with the SEC and banking regulators concerning these and related matters and is working diligently to resolve them in a full and comprehensive manner. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.
 
In the 2004 third and fourth quarters, the Company recorded certain integration planning and system conversion expenses, which totaled $3.6 million, related to this pending acquisition. (See Table 3 and Note 23 of the Notes to Consolidated Financial Statements.)

  12.  PROPERTY LEASE IMPAIRMENT — As a result of the 2004 fourth quarter property valuation review, a $7.8 million property lease impairment was recognized. (See Table 3.)
 
  13.  LONG-TERM DEBT EXTINGUISHMENT — In the fourth quarter of 2003, the Company prepaid $250 million of high-cost, repurchase agreements, resulting in a $15.3 million loss being recorded in non-interest expense. This debt, which carried an average rate of 4.98% and matured in 2006, was replaced by funding at significantly lower rates. (See Table 3 and Note 13 of the Notes to Consolidated Financial Statements.)
 
  14.  ONE-TIME ADJUSTMENT TO CONSOLIDATED SECURITIZATION — In the 2003 third quarter, an automobile securitization trust was consolidated with the adoption of FIN 46. Related to the trust were two foreign companies that were also consolidated. In the 2004 fourth quarter, the Company learned of adjustments related to earnings that these entities had realized on the invested cash that remains offshore. Since the residual earnings offset the funding cost of this structure, this one-time funding cost adjustment lowered interest expense by $3.7 million in the fourth quarter. (See Table 3.)

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

The following table quantifies the earnings impact of the significant factors noted in #3-14 above on the specified periods.

Table 3 — Significant Items Influencing Earnings Performance Comparison(1)

                                                   
Year Ended December 31,

2004 2003 2002

(in thousands of dollars) Pre-tax EPS Pre-tax EPS Pre-tax EPS

Income before income taxes — GAAP
  $ 552,666             $ 523,987             $ 522,705          
Earnings per share, after tax
          $ 1.71             $ 1.61             $ 1.33  
 
Change from prior year — $
            0.10               0.28               0.79  
 
Change from prior year — %
            6.2 %             20.9 %             N.M. %

Favorable (unfavorable) impact:
                                               
SEC related expenses and accruals
  $ (13,597 )   $ (0.05 )   $ (6,859 )   $ (0.02 )   $     $  
Investment securities gains
    15,763       0.04       5,258       0.01       4,902       0.01  
Gain on sale of automobile loans
    14,206       0.04       40,039       0.11              
Single commercial credit recovery
    11,095       0.03                          
Property lease impairment
    (7,846 )     (0.02 )                        
Mortgage servicing right (MSR) temporary (impairment)
recovery net of hedge related gains
    (7,174 )     (0.02 )     14,957       0.04       (13,395 )     (0.04 )
One-time adjustment to consolidated securitization
    3,682       0.01                          
Unizan system conversion expense
    (3,610 )     (0.01 )                        
Restructuring releases (charges)
    1,151       N.M.       6,666       0.02       (48,973 )     (0.13 )
Cumulative effect of change in accounting principle (2)
                n/a       (0.06 )            
Gain on sale of branch offices
                13,112       0.04              
Long-term debt extinguishment
                (15,250 )     (0.04 )            
Loss from Florida operations
                            (2,329 )     (0.01 )
Gain on sale of Florida operations
                            182,470       0.25  
Merchant services gain
                            24,550       0.07  

N.M., not a meaningful value.

n/a, not applicable.

(1)  See Significant Factors Influencing Financial Performance section.
 
(2)  Only reflected in the income statement on an after tax basis of $13.3 million.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Table 4 — Consolidated Average Balance Sheet and Net Interest Margin Analysis

                                                                                   
Average Balances

Change from 2003 Change from 2002
Fully taxable equivalent basis(1)

(in millions of dollars) 2004 Amount % 2003 Amount % 2002 2001 2000

Assets
                                                                       
Interest bearing deposits in banks
  $ 66     $ 29       78.4 %   $ 37     $ 4       12.1 %   $ 33     $ 7     $ 6  
Trading account securities
    105       91       N.M.       14       7       N.M.       7       25       15  
Federal funds sold and securities purchased under resale agreements
    319       232       N.M.       87       15       20.8       72       107       87  
Loans held for sale
    243       (321 )     (56.9 )     564       242       75.2       322       360       109  
Investment securities:
                                                                       
 
Taxable
    4,425       892       25.2       3,533       674       23.6       2,859       3,144       4,316  
 
Tax-exempt
    412       78       23.4       334       199       N.M.       135       174       273  

       
Total investment securities
    4,837       970       25.1       3,867       873       29.2       2,994       3,318       4,589  

Loans and leases:(6)
                                                                       
 
Commercial:
                                                                       
   
Middle market commercial and industrial
    4,456       (177 )     (3.8 )     4,633       (177 )     (3.7 )     4,810       5,075       4,938  
   
Middle market real estate:
                                                                       
     
Construction
    1,420       201       16.5       1,219       68       5.9       1,151       1,040       976  
     
Commercial
    1,922       122       6.8       1,800       130       7.8       1,670       1,522       1,380  

       
Total middle market commercial real estate
    3,342       323       10.7       3,019       198       7.0       2,821       2,562       2,356  

     
Small business commercial and industrial and commercial real estate
    2,003       216       12.1       1,787       145       8.8       1,642       2,574       2,526  

         
Total commercial
    9,801       362       3.8       9,439       166       1.8       9,273       10,211       9,820  

 
Consumer:
                                                                       
   
Automobile loans
    2,285       (975 )     (29.9 )     3,260       516       18.8       2,744       N.M.       N.M.  
   
Automobile leases
    2,192       769       54.0       1,423       971       N.M.       452       N.M.       N.M.  

     
Automobile loans and leases
    4,477       (206 )     (4.4 )     4,683       1,487       46.5       3,196       2,839       3,123  

   
Home equity(3)(5)
    4,187       746       21.7       3,441       412       13.6       3,029       3,334       2,921  
   
Residential mortgage(4)
    3,212       1,186       58.5       2,026       588       40.9       1,438       1,048       1,379  
   
Other loans(5)
    450       15       3.4       435       (46 )     (9.6 )     481       654       599  

         
Total consumer
    12,326       1,741       16.4       10,585       2,441       30.0       8,144       7,875       8,022  

Total loans and leases
    22,127       2,103       10.5       20,024       2,607       15.0       17,417       18,086       17,842  

Allowance for loan and lease losses
    (298 )     32       (9.7 )     (330 )     14       (4.1 )     (344 )     (286 )     (256 )

Net loans and leases
    21,829       2,135       10.8       19,694       2,621       15.4       17,073       17,800       17,586  

Total earning assets
    27,697       3,104       12.6       24,593       3,748       18.0       20,845       21,903       22,648  

Operating lease assets
    897       (800 )     (47.1 )     1,697       (905 )     (34.8 )     2,602       2,970       2,751  
Cash and due from banks
    843       69       8.9       774       17       2.2       757       912       1,008  
Intangible assets
    216       (2 )     (0.9 )     218       (75 )     (25.6 )     293       736       709  
All other assets
    2,078       58       2.9       2,020       110       5.8       1,910       1,891       1,729  

Total Assets
  $ 31,433     $ 2,461       8.5 %   $ 28,972     $ 2,909       11.2 %   $ 26,063     $ 28,126     $ 28,589  

Liabilities and Shareholders’ Equity
                                                                       
Deposits:
                                                                       
 
Non-interest bearing deposits
  $ 3,230     $ 150       4.9 %   $ 3,080     $ 178       6.1 %   $ 2,902     $ 3,304     $ 3,421  
 
Interest bearing demand deposits
    7,207       1,014       16.4       6,193       1,032       20.0       5,161       5,005       4,291  
 
Savings deposits
    2,829       27       1.0       2,802       (51 )     (1.8 )     2,853       3,478       3,563  
 
Retail certificates of deposit
    2,417       (285 )     (10.5 )     2,702       (917 )     (25.3 )     3,619       4,980       4,930  
 
Other domestic time deposits
    602       (58 )     (8.8 )     660       (70 )     (9.6 )     730       903       942  

       
Total core deposits
    16,285       848       5.5       15,437       172       1.1       15,265       17,670       17,147  

Domestic time deposits of $100,000 or more
    865       63       7.9       802       (49 )     (5.8 )     851       1,280       1,502  
Brokered time deposits and negotiable CDs
    1,837       418       29.5       1,419       688       94.1       731       128       502  
Foreign time deposits
    508       8       1.6       500       163       48.4       337       283       539  

         
Total deposits
    19,495       1,337       7.4       18,158       974       5.7       17,184       19,361       19,690  

Short-term borrowings
    1,410       (190 )     (11.9 )     1,600       (256 )     (13.8 )     1,856       2,099       1,966  
Federal Home Loan Bank advances
    1,271       13       1.0       1,258       979       N.M.       279       19       13  
Subordinated notes and other long-term debt, including preferred capital securities
    5,379       820       18.0       4,559       1,224       36.7       3,335       3,411       4,005  

         
Total interest bearing liabilities
    24,325       1,830       8.1       22,495       2,743       13.9       19,752       21,586       22,253  

All other liabilities
    1,504       303       25.2       1,201       31       2.6       1,170       905       723  
Shareholders’ equity
    2,374       178       8.1       2,196       (43 )     (1.9 )     2,239       2,331       2,192  

Total Liabilities and Shareholders’ Equity
  $ 31,433     $ 2,461       8.5 %   $ 28,972     $ 2,909       11.2 %   $ 26,063     $ 28,126     $ 28,589  

Net interest income
                                                                       

Net interest rate spread
                                                                       
Impact of non-interest bearing funds on margin
                                                                       

Net interest margin
                                                                       

N.M., not a meaningful value.

(1)  Fully taxable equivalent (FTE) yields are calculated assuming a 35% tax rate.
 
(2)  Loan and lease and deposit average rates include impact of applicable derivatives and non-deferrable fees.
 
(3)  Home equity includes personal lines of credit and other consumer loans secured by first or junior mortgages on residential property originated and underwritten through the Company’s retail banking channel. Reclassification of prior period balances has been made to conform to this presentation, resulting in an increase to previously reported home equity loans and a decrease to previously reported residential mortgage loans.

36


 

MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

                                                                             
Interest Income/Expense Average Rate(2)

2004 2003 2002 2001 2000 2004 2003 2002 2001 2000

$ 0.7     $ 0.6     $ 0.8     $ 0.2     $ 0.3       1.05 %     1.53 %     2.38 %     3.43 %     5.03 %
  4.4       0.6       0.3       1.3       1.1       4.15       4.02       4.11       5.13       7.11  
  5.5       1.6       1.1       4.5       5.5       1.73       1.80       1.56       4.19       6.33  
  13.0       30.0       20.5       25.0       8.7       5.35       5.32       6.35       6.95       7.96  
  171.7       159.6       173.0       206.9       269.5       3.88       4.52       6.06       6.58       6.24  
  28.8       23.5       10.1       13.0       20.8       6.98       7.04       7.42       7.49       7.61  

  200.5       183.1       183.1       219.9       290.3       4.14       4.73       6.12       6.63       6.33  

  196.5       224.1       262.0       353.4       414.3       4.41       4.95       5.45       6.96       8.39  
  58.0       52.1       52.6       72.7       87.7       4.09       4.09       4.57       6.99       8.98  
  85.3       88.0       98.7       113.3       115.4       4.44       4.84       5.91       7.44       8.36  

  143.3       140.1       151.3       186.0       203.1       4.29       4.54       5.36       7.26       8.62  

  110.3       105.6       110.6       204.8       230.6       5.50       5.91       6.73       7.96       9.13  

  450.1       469.8       523.9       744.2       848.0       4.59       5.00       5.65       7.29       8.64  

  165.1       242.1       237.9       253.8       271.4       7.22       7.38       8.67       N.M       N.M  
  109.6       72.8       23.2       1.2       (0.5 )     5.00       5.09       5.14       N.M       N.M  

  274.7       314.9       261.1       255.0       270.9       6.14       6.68       8.17       8.94       8.67  

  205.4       174.1       180.6       274.5       249.0       4.91       5.14       5.96       8.23       8.52  
  175.9       111.4       91.4       81.6       107.1       5.48       5.85       6.55       8.19       8.00  
  28.7       29.5       35.6       54.9       60.7       6.38       6.71       7.40       8.40       10.14  

  684.7       629.9       568.7       666.0       687.7       5.56       5.93       6.98       8.44       8.57  

  1,134.8       1,099.7       1,092.6       1,410.2       1,535.7       5.11       5.49       6.27       7.79       8.61  



  1,358.9       1,315.6       1,298.4       1,661.1       1,841.6       4.89       5.35       6.23       7.58       8.13  

                                                         
  74.1       73.0       88.9       133.5       143.1       1.03       1.18       1.71       2.64       3.30  
  24.4       41.7       50.6       106.7       145.7       0.86       1.49       1.77       3.07       4.09  
  81.2       100.4       165.6       281.5       282.2       3.36       3.68       4.58       5.65       5.72  
  19.7       26.0       29.6       48.2       52.0       3.27       3.86       4.05       5.34       5.52  

  199.4       241.1       334.7       569.9       623.0       1.53       1.94       2.70       3.95       4.52  

  20.5       18.5       28.8       66.8       90.4       2.37       2.50       3.39       5.22       6.01  
  33.1       24.1       17.3       6.6       31.9       1.80       1.70       2.36       5.12       6.35  
  4.1       4.6       4.9       10.8       34.0       0.82       0.92       1.47       3.82       6.31  

  257.1       288.3       385.7       654.1       779.3       1.58       1.91       2.69       4.06       4.77  

  13.0       15.7       29.0       95.8       113.1       0.93       0.98       1.56       4.57       5.75  
  33.3       24.4       5.6       1.2       0.8       2.57       1.94       2.00       6.17       6.32  
  132.5       128.5       123.3       188.4       270.0       2.46       2.82       3.70       5.52       6.74  

  435.9       456.9       543.6       939.5       1,163.2       1.79       2.03       2.75       4.34       5.22  


                             
$ 923.0     $ 858.7     $ 754.8     $ 721.6     $ 678.4                                          

                             
                                          3.10       3.32       3.48       3.24       2.91  
                                          0.23       0.17       0.14       0.05       0.09  

                                          3.33 %     3.49 %     3.62 %     3.29 %     3.00 %

(4)  Residential mortgage includes loans secured by first mortgages on residential property originated and underwritten through the Company’s mortgage banking channel. Reclassification of prior period balances has been made to conform to this presentation, resulting in an increase to previously reported home equity loans and a decrease to previously reported residential mortgage loans.
 
(5)  Effective December 31, 2004, unsecured personal credit lines were reclassified from “home equity loans” to “other loans” in all periods presented.
 
(6)  For purposes of this analysis, non-accrual loans are reflected in the average balances of loans.

37


 

MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Net Interest Income

(This section should be read in conjunction with Significant Factors 1-6 and 14.)

The Company’s primary source of revenue is net interest income, which is the difference between interest income on earning assets, primarily loans, direct financing leases, and securities and interest expense on funding sources, including interest-bearing deposits and borrowings. Earning asset balances and related funding, as well as changes in the levels of interest rates, impact net interest income. The difference between the average yield on earning assets and the average rate paid for interest-bearing liabilities is the net interest spread. Noninterest-bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. The impact of the noninterest-bearing sources of funds, often referred to as “free” funds, is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. Given the “free” nature of noninterest-bearing sources of funds, the net interest margin is generally higher than the net interest spread. Both the net interest spread and net interest margin are presented on a fully taxable equivalent basis, which means that tax-free interest income has been adjusted to a pre-tax equivalent income, assuming a 35% tax rate.

Table 4 shows average annual balance sheets and net interest margin analysis for five years. It details average balances for total assets and liabilities, as well as shareholders’ equity, and their various components, most notably loans and leases, deposits, and borrowings. It also shows the corresponding interest income or interest expense associated with each earning asset and interest-bearing liability category along with the average rate with the difference resulting in the net interest spread. The net interest spread plus the positive impact from the noninterest-bearing funds represent the net interest margin.

Table 5 shows changes in fully taxable equivalent interest income, interest expense, and net interest income due to volume and rate variances for major categories of earning assets and interest-bearing liabilities. The change in interest income or expense not solely due to changes in volume or rates has been allocated in proportion to the absolute dollar amount of the change in volume and rate.

Table 5 — Change in Net Interest Income Due to Changes in Average Volume and Interest Rates(1)

                                                 
2004 2003

Increase (Decrease) From Increase (Decrease) From
Previous Year Due To Previous Year Due To

Fully tax equivalent basis(2) Yield/ Yield/
(in millions of dollars) Volume Rate Total Volume Rate Total

Loans and direct financing leases
  $ 110.8     $ (75.7 )   $ 35.1     $ 152.4     $ (145.3 )   $ 7.1  
Securities
    42.1       (24.7 )     17.4       46.7       (46.7 )      
Other earning assets
    1.4       (10.5 )     (9.1 )     12.7       (2.6 )     10.1  

Total interest income in earning assets
    154.3       (110.9 )     43.4       211.8       (194.6 )     17.2  

Deposits
    21.5       (52.7 )     (31.2 )     20.5       (117.9 )     (97.4 )
Short-term borrowings
    (1.8 )     (0.9 )     (2.7 )     (3.5 )     (9.8 )     (13.3 )
Federal Home Loan Bank advances
    0.3       8.6       8.9       19.0       (0.2 )     18.8  
Subordinated notes and other long-term debt, including capital securities
    21.6       (13.9 )     7.7       216.9       (211.7 )     5.2  

Total interest expense in interest-bearing liabilities
    41.6       (58.9 )     (17.3 )     252.9       (339.6 )     (86.7 )

Net interest income before funding cost adjustment
    112.7       (52.0 )     60.7       (41.1 )     145.0       103.9  
Funding cost adjustment
          3.7       3.7                    

Net interest income
  $ 112.7     $ (48.3 )   $ 64.4     $ (41.1 )   $ 145.0     $ 103.9  

(1)  The change in interest rates due to both rate and volume has been allocated between the factors in proportion to the relationship of the absolute dollar amounts of the change in each.
 
(2)  Calculated assuming a 35% tax rate.

2004 versus 2003 Performance

Fully taxable equivalent net interest income increased $64.4 million, or 7%, in 2004 from 2003. This reflected the benefit of a 13% increase in average earning assets, partially offset by the negative impact of an effective 5% decline in the net interest margin to 3.33% from 3.49%.

The net interest margin declined in the first half of 2004 and primarily reflected the impact from the sale of higher-margin automobile loans. Such sales totaled $1.4 billion in the first half of 2004 but only $0.2 billion in the 2004 third quarter. The decline in the net interest margin in the first half of the year also reflected, to a lesser degree, the growth in lower-margin investment securities, as well as

38


 

MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

the impact of rising interest rates. The net interest margin stabilized in the second half of the year as automobile loan sales diminished and lower cost deposit growth was strong.

2003 versus 2002 Performance

Fully taxable equivalent net interest income increased $103.9 million, or 14%, in 2003 from 2002. This reflected the benefit of an 18% increase in average earning assets, partially offset by the negative impact of an effective 4% decline in the net interest margin to 3.49% from 3.62%.

The decline in the net interest margin reflected the impact of declining loan portfolio rates due to lower rates on variable-rate loan products, as well as prepayments and repayments of fixed-rate loans, most notably mortgages. The rate on the securities portfolio also declined, reflecting the same prepayments and repayments of mortgage-related securities, with resultant reinvestment at lower market rates. Deposit rates declined to a lesser degree than loan or securities rates reflecting competitive pressures in the deposit markets. Two other factors contributing to a lower net interest margin were the growth of lower-yielding investment securities and the shift to lower-yield, but lower-risk, loans.

Balance Sheet

(This section should be read in conjunction with Significant Factors 1-6.)

TOTAL CREDIT EXPOSURE PORTFOLIO MIX

An overall corporate objective is to maintain a relative balance between the various credit portfolios so as to avoid undue concentrations. As shown in Table 6, at December 31, 2004, total credit exposure was $24.1 billion. Of this amount, $13.3 billion, or 55%, represented total consumer loans, $10.3 billion, or 43%, total commercial loans, and $0.6 billion, or 2%, operating lease assets.

Related to the overall corporate objective, a specific objective has been to reduce the relative level of total automobile exposure (the sum of automobile loans, automobile leases, and operating lease assets) from its 33% level at the end of 2002. As shown in Table 6, the total automobile exposure at December 31, 2004 was 21%.

In contrast, another related specific objective was to increase the relative level of lower-risk residential mortgages and home equity loans. Progress was made on this objective as well. At December 31, 2004, such loans represented 35% of total credit exposure, up from 22% at the end of 2002.

Since the end of 2002, the level of total commercial loans and leases has remained relatively constant at 42%-43% of total credit exposure. However, C&I loans declined to 19% at year end 2004 from 22% at December 31, 2002, reflecting weak demand, but also a specific objective to reduce exposure to large individual credits, as well as a strategy to focus commercial lending to customers with existing or potential relationships within the Company’s primary markets. Conversely, since the end of 2002, small business loans increased to 9% from 8%, reflecting strategies to grow this important targeted business segment. (See Table 6.)

39


 

MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Table 6 — Loan and Lease Portfolio Composition

                                                                                         
At December 31,

(in millions of dollars) 2004 2003 2002 2001 2000

Commercial(1)
                                                                               
 
Middle market commercial and industrial
  $ 4,666       19.3 %   $ 4,416       19.7 %   $ 4,757       21.7 %   $ 4,922       21.7 %   $ 5,030       22.9 %
 
Middle market real estate:
                                                                               
   
Construction
    1,602       6.6       1,264       5.7       983       4.5       1,150       5.1       999       4.6  
   
Commercial
    1,917       7.9       1,919       8.6       1,896       8.7       1,575       6.9       1,484       6.8  

     
Total middle market real estate
    3,519       14.5       3,183       14.3       2,879       13.2       2,725       12.0       2,483       11.4  

 
Small business commercial and industrial and commercial real estate
    2,118       8.8       1,887       8.4       1,695       7.7       2,607       11.5       2,581       11.8  

       
Total commercial
    10,303       42.6       9,486       42.4       9,331       42.6       10,254       45.2       10,094       46.1  

Consumer:
                                                                               
 
Automobile loans
    1,949       8.1       2,992       13.4       3,042       13.9       2,853       12.6       2,480       11.3  
 
Automobile leases
    2,443       10.1       1,902       8.5       874       4.0       110       0.5       147       0.7  
 
Home equity
    4,555       18.9       3,734       16.7       3,142       14.3       3,518       15.5       2,098       9.6  
 
Residential mortgage
    3,829       15.9       2,531       11.3       1,746       8.0       1,129       5.0       1,058       4.8  
 
Other loans
    481       2.0       430       1.9       452       2.1       607       2.7       1,746       8.0  

       
Total consumer
    13,257       55.0       11,589       51.8       9,256       42.3       8,217       36.3       7,529       34.4  

Total loans and direct financing leases
    23,560       97.6       21,075       94.2       18,587       84.9       18,471       81.5       17,623       80.5  

Operating lease assets
    587       2.4       1,260       5.6       2,201       10.0       3,006       13.2       2,934       13.4  
Securitized loans
                37       0.2       1,119       5.1       1,225       5.4       1,371       6.3  

Total credit exposure
  $ 24,147       100.0 %   $ 22,372       100.0 %   $ 21,907       100.0 %   $ 22,702       100.0 %   $ 21,928       100.0 %

Total automobile exposure (2)
  $ 4,979       20.6 %   $ 6,191       27.7 %   $ 7,236       33.0 %   $ 7,194       31.7 %   $ 6,932       31.6 %

(1)  There were no commercial loans outstanding that would be considered a concentration of lending to a particular industry or group of industries.
 
(2)  Total loans and leases, operating lease assets, and securitized loans.

AVERAGE BALANCE SHEET DISCUSSION — LOANS, LEASES, AND OTHER EARNING ASSETS

2004 versus 2003 Performance

Growth in average total loans and leases accounted for most of the 13% increase in earning assets, though investment securities also increased reflecting the reinvestment of a portion of the proceeds from automobile loan sales.

Average total loans and leases increased 11% from the prior year. Most of this increase reflected growth in average total consumer loans where the strong growth in residential mortgage and home equity loans was only partially offset by a decline in automobile loans reflecting the sale of $1.5 billion of automobile loans in 2004. Average total commercial loans increased 4% reflecting growth in CRE and small business loans, partially offset by a decline in average C&I loans.

2003 versus 2002 Performance

Growth in average total loans and leases accounted for most of the 18% increase in average earning assets, though investment securities also increased reflecting the reinvestment of a portion of the proceeds from automobile loan sales.

Average total loans and leases increased 15% from the prior year. Most of this increase reflected growth in average total consumer loans where the growth in automobile loans and leases, residential mortgages, and home equity loans was strong. The growth in average automobile loans and leases reflected $2.8 billion of new automobile loan originations, as well as the consolidation of $1.0 billion of securitized automobile loans due to the adoption of FIN 46, partially offset by the impact from the sale of $2.1 billion of automobile loans. Average total commercial loans increased only 2% reflecting good growth in CRE and small business loans, partially offset by a decline in average C&I loans.

AVERAGE BALANCE SHEET DISCUSSION — DEPOSITS AND OTHER FUNDING

2004 versus 2003 Performance

Average total deposits in 2004 increased 7% from the prior year, primarily reflecting 5% growth in average core deposits. Growth in interest-bearing demand deposits, and to a lesser degree noninterest-bearing deposits, accounted for virtually all of the growth in average core deposits, as average retail certificates of deposits (CDs) declined. With interest rates near historical low levels, demand for retail CDs was greatly diminished in the first half of 2004. However, retail CDs grew in the second half of the year as interest rates and
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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

customer demand for retail CDs increased. In addition to growth in average core deposits, the increase in average total deposits also reflected a 29% increase in brokered time deposits and negotiable CDs, which, in comparison with rates on retail CDs, remained a relatively lower cost of funds.

Management uses the non-core funding ratio (total liabilities less core deposits and accrued expenses and other liabilities divided by total assets) to measure the extent to which funding is dependent on wholesale deposits and borrowing sources. For 2004, the average non-core funding ratio was 36%, up from 35% in 2003. The average non-core funding ratio reached a peak of 38% in the first quarter of 2004 as strong loan growth outpaced core deposit growth. Subsequent loan sales, as well as successful core deposit growth initiatives, reduced average non-core funding requirements to 34% by the 2004 fourth quarter.

2003 versus 2002 Performance

Average total deposits in 2003 increased 6% from the prior year, primarily reflecting 94% growth in average brokered time deposits and negotiable CDs, which were relatively lower in cost compared with retail CDs. Average total core deposits increased only 1%, reflecting 20% growth in average interest-bearing demand deposits virtually offset by a 25% decline in average retail CDs, which became a relatively expensive source of funds, especially in the first half of 2003. Reflecting this, interest-bearing demand deposits were emphasized in deposit growth initiatives, whereas retail CDs were de-emphasized.

For 2003, the average non-core funding ratio was 35%, up from 28% in 2002. This reflected the fact that balance sheet growth during 2003 exceeded that of core deposits and, therefore, required funding through brokered CDs, Federal Home Loan Bank (FHLB) advances, and other long-term debt. Though it had no significant impact on average balances, $250 million of secured long-term debt was extinguished in the fourth quarter of 2003.

Provision for Credit Losses

(This section should be read in conjunction with Significant Factor 4 and the Credit Risk section.)

The provision for credit losses is the expense necessary to maintain the ALLL and the AULC at a level adequate to absorb Management’s estimate of probable inherent credit losses in the loan and lease portfolio and the portfolio of unfunded loan commitments.

Provision expense for 2004 was $55.1 million, down $108.9 million, or 66%, from $164.0 million in 2003, which in turn declined $30.4 million, or 16%, from 2002. The declines in both years reflected the significant improvement in overall credit quality as reflected by a combination of factors including lower net charge-offs, including a recovery of $11.1 million in 2004 and lower levels of non-performing assets (NPAs), as well as the overall lower risk inherent in the loan and lease portfolio resulting from strategies to lower the overall risk profile of the balance sheet, partially offset by additional provision expense related to loan growth.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Non-Interest Income

(This section should be read in conjunction with Significant Factors 1, 3, 4, 6, and 9.)

Non-interest income for the three years ended December 31, 2004 was as follows:

Table 7 — Non-Interest Income

                                                         
Year Ended December 31,

Change from 2003 Change from 2002


(in thousands of dollars) 2004 Amount % 2003 Amount % 2002

Service charges on deposit accounts
  $ 171,115     $ 3,275       2.0 %   $ 167,840     $ 14,276       9.3 %   $ 153,564  
Trust services
    67,410       5,761       9.3       61,649       (402 )     (0.6 )     62,051  
Brokerage and insurance income
    54,799       (3,045 )     (5.3 )     57,844       (4,265 )     (6.9 )     62,109  
Bank owned life insurance income
    42,297       (731 )     (1.7 )     43,028       (95 )     (0.2 )     43,123  
Other service charges and fees
    41,574       128       0.3       41,446       (1,442 )     (3.4 )     42,888  
Mortgage banking
    32,296       (25,884 )     (44.5 )     58,180       26,147       81.6       32,033  
Securities gains
    15,763       10,505       N.M.       5,258       356       7.3       4,902  
Other
    92,047       988       1.1       91,059       14,119       18.4       76,940  

Sub-total before operating lease income
    517,301       (9,003 )     (1.7 )     526,304       48,694       10.2       477,610  
Operating lease income
    287,091       (202,607 )     (41.4 )     489,698       (167,376 )     (25.5 )     657,074  

Sub-total including operating lease income
    804,392       (211,610 )     (20.8 )     1,016,002       (118,682 )     (10.5 )     1,134,684  

Gain on sales of automobile loans
    14,206       (25,833 )     (64.5 )     40,039       40,039       N.M.        
Gain on sale of branch offices
          (13,112 )     N.M.       13,112       13,112       N.M.        
Gain on sale of Florida operations
                            (182,470 )     N.M.       182,470  
Merchant services gain
                            (24,550 )     N.M.       24,550  

Total non-interest income
  $ 818,598     $ (250,555 )     (23.4 )%   $ 1,069,153     $ (272,551 )     (20.3 )%   $ 1,341,704  

N.M., not a meaningful value.

Table 8 — Mortgage Banking Income

                                                           
Year Ended December 31,

Change from 2003 Change from 2002


(in thousands of dollars) 2004 Amount % 2003 Amount % 2002

 
Origination fees
  $ 12,377     $ (4,895 )     (28.3 )%   $ 17,272     $ 6,725       63.8 %   $ 10,547  
 
Secondary marketing
    8,340       (15,267 )     (64.7 )     23,607       2,343       11.0       21,264  
 
Servicing fees
    21,696       4,790       28.3       16,906       5,476       47.9       11,430  
 
Amortization of capitalized servicing
    (19,019 )     6,947       (26.8 )     (25,966 )     (13,915 )     N.M.       (12,051 )
 
MSR recovery/(impairment)
    1,378       (13,579 )     (90.8 )     14,957       29,070       N.M.       (14,113 )
 
Other mortgage banking income
    7,524       (3,880 )     (34.0 )     11,404       (3,552 )     (23.7 )     14,956  

Total mortgage banking income
  $ 32,296     $ (25,884 )     (44.5 )%   $ 58,180     $ 26,147       81.6 %   $ 32,033  

Capitalized mortgage servicing rights(1)
  $ 77,107     $ 6,020       8.5 %   $ 71,087     $ 41,816       N.M. %   $ 29,271  
Total mortgages serviced for others(1)
    6,861,000       467,000       7.3       6,394,000       2,618,000       69.3       3,776,000  
 
MSR recovery/(impairment)
  $ 1,378     $ (13,579 )     (90.8 )%   $ 14,957     $ 29,070       N.M. %   $ (14,113 )
 
Net trading losses related to MSR hedging
    (10,002 )     (10,002 )     N.M.             (718 )     N.M.       718  
 
Net interest income related to MSR hedging
    1,450       1,450       N.M.                          

Net impact of MSRs/ MSR hedging
  $ (7,174 )   $ (22,131 )     N.M. %   $ 14,957     $ 28,352       N.M. %   $ (13,395 )

N.M., not a meaningful value.

(1)  At year end.

2004 versus 2003 Performance

Non-interest income for 2004 declined $250.6 million, or 23%, from 2003. Comparisons with prior-period results were heavily influenced by the decline in operating leases and related operating lease income. These declines are expected to continue, though diminish over time, as all automobile leases originated since April 2002 are direct financing leases with income reflected in net interest income, not non-interest income. Reflecting the run-off of the operating lease portfolio, operating lease income declined
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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

$202.6 million, or 41%, from 2003. Excluding operating lease income, non-interest income decreased $47.9 million, or 8%, from a year ago with the primary drivers being:

  –  $25.9 million decline in mortgage banking income reflected a combination of factors, all basically related to the lower level of mortgage originations as interest rates increased during 2004. Such factors included lower net secondary marketing revenue as sales declined, and a 91% reduction in MSR recovery.
 
  –  $25.8 million decline in gains on the sale of automobile loans reflecting both a decline in loan sales, $1.5 billion in 2004 vs. $2.1 billion in 2003, as well as lower relative gains on the sales. The spread between the average interest rate on the pool of sold loans and the current market rates at the time of the sale was narrower on the loan pools sold in 2004 than in 2003, thus resulting in lower gains.
 
  –  $13.1 million decline in gains on sale of branch offices reflecting no such sales in 2004.
 
  –  $3.0 million decline in brokerage and insurance income primarily due to lower title insurance-related fees, and reduced credit life insurance revenue, as well as a decline in annuity fee income due to a 6% decline in annuity sales.

Partially offset by:

  –  $10.5 million increase in securities gains primarily related to MSR temporary impairment hedging activity.
 
  –  $5.8 million increase in trust services income primarily due to higher personal trust income and proprietary mutual fund fees.
 
  –  $3.3 million increase in service charges on deposit accounts reflecting higher NSF and overdraft fees, partially offset by lower personal and commercial account maintenance charges.

2003 versus 2002 Performance

Non-interest income for 2003 declined $272.6 million, or 20%, from 2002. As noted above, comparisons with prior-period results were heavily influenced by the decline in operating leases and related operating lease income. Reflecting the run-off of the operating lease portfolio, operating lease income declined $167.4 million, or 25%, from 2002. Excluding operating lease income, non-interest income decreased $105.2 million, or 15%, from the prior year with the primary drivers being:

  –  $182.5 million related to the 2002 gain on the sale of the Florida banking operations.
 
  –  $24.6 million related to the 2002 gain on the Merchant Service restructuring.
 
  –  $4.3 million decline in brokerage and insurance income principally reflecting the loss of $6.9 million of revenue due to the 2002 sale of the Florida banking and insurance operations, partially offset by a $2.7 million increase in income generated by other areas, mostly related to insurance agency revenue from mortgage refinancing and title insurance fees.

Partially offset by:

  –  $40.0 million of gains on the sale of automobile loans compared with none in 2002 as this program was initiated in 2003.
 
  –  $26.1 million increase in mortgage banking income, including $29.1 million for recoveries of previously recognized MSR valuation temporary impairments. A record $6.1 billion of mortgages were originated in 2003 due to heavy refinancing activity as borrowers continued to take advantage of very low interest rates. (See Note 5 of the Notes to the Consolidated Financial Statements.)
 
  –  $14.3 million increase in deposit service charges. This increase reflected the growth in deposit accounts, as well as an increase in consumer NSF service charges and overdraft fees, partially offset by the loss of $4.2 million in service charge revenue due to the 2002 sale of the Florida banking operations.
 
  –  $14.1 million increase in other income reflecting a combination of items including higher lease termination income and fees, securitization income, fees from customer interest rate swaps, and customer trading gains.
 
  –  $13.1 million of gains related to the 2003 sale of banking offices in West Virginia.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Non-Interest Expense

(This section should be read in conjunction with Significant Factors 1, 6, 7, 10, 11, 12 and 13.)

Non-interest expense for the three years ended December 31, 2004 was as follows:

Table 9 — Non-Interest Expense

                                                           
Year Ended December 31,

Change from 2003 Change from 2002


(in thousands of dollars) 2004 Amount % 2003 Amount % 2002

 
Salaries
  $ 376,268     $ 14,826       4.1 %   $ 361,442     $ 14,789       4.3 %   $ 346,653  
 
Benefits
    109,538       23,717       27.6       85,821       14,437       20.2       71,384  

Personnel costs
    485,806       38,543       8.6 %     447,263       29,226       7.0 %     418,037  

 
Net occupancy
    75,941       13,460       21.5       62,481       2,942       4.9       59,539  
 
Outside data processing and other services
    72,115       5,997       9.1       66,118       (1,250 )     (1.9 )     67,368  
 
Equipment
    63,342       (2,579 )     (3.9 )     65,921       (2,402 )     (3.5 )     68,323  
 
Professional services
    36,876       (5,572 )     (13.1 )     42,448       9,363       28.3       33,085  
 
Marketing
    26,489       (1,001 )     (3.6 )     27,490       (421 )     (1.5 )     27,911  
 
Telecommunications
    19,787       (2,192 )     (10.0 )     21,979       (682 )     (3.0 )     22,661  
 
Printing and supplies
    12,463       (546 )     (4.2 )     13,009       (2,189 )     (14.4 )     15,198  
 
Amortization of intangibles
    817       1       0.1       816       (1,203 )     (59.6 )     2,019  
 
Other
    93,281       12,501       15.5       80,780       (11,283 )     (12.3 )     92,063  

Sub-total before operating lease expense
    886,917       58,612       7.1       828,305       22,101       2.7       806,204  
 
Operating lease expense
    236,478       (156,792 )     (39.9 )     393,270       (125,700 )     (24.2 )     518,970  

Sub-total including operating lease expense     1,123,395       (98,180 )     (8.0 )     1,221,575       (103,599 )     (7.8 )     1,325,174  

 
Restructuring reserve (releases) charges
    (1,151 )     5,515       (82.7 )     (6,666 )     (55,639 )     N.M.       48,973  
 
Loss on early extinguishment of debt
          (15,250 )     N.M.       15,250       15,250       N.M.        

Total non-interest expense
  $ 1,122,244     $ (107,915 )     (8.8 )%   $ 1,230,159     $ (143,988 )     (10.5 )%   $ 1,374,147  

N.M., not a meaningful value.

2004 versus 2003 Performance

Non-interest expense declined $107.9 million, or 9%, from 2003. Comparisons with prior-period results were significantly influenced by the decline in operating lease expense as the operating lease portfolio continued to run-off. These declines are expected to continue, though diminish over time. Operating lease expense declined $156.8 million, or 40%, from 2003. Excluding operating lease expense, non-interest expense increased $48.9 million, or 6%, from 2003 reflecting:

  –  $38.5 million increase in personnel costs primarily related to higher retirement and insurance benefit expenses, and to a lesser degree, higher salaries.
 
  –  $13.5 million increase in net occupancy expense reflecting a $7.8 million property lease impairment, as well as higher depreciation and lower rental income.
 
  –  $12.5 million increase in other expense impacted by SEC-related expenses and accruals. (See discussion below.)
 
  –  $6.0 million increase in outside data processing expenses including Unizan-related expenses. (See discussion below.)
 
  –  $5.5 million decline in restructuring reserve releases, as such releases totaled $1.2 million in 2004, down from $6.7 million of such releases in 2003.

Partially offset by:

  –  $15.3 million related to the loss on the early extinguishment of debt in 2003.
 
  –  $5.6 million decline in professional services, primarily reflecting lower consulting expenses.

As mentioned above, SEC-related expenses and accruals, as well as expenses related to Unizan integration planning and systems conversions, contributed to the change in expense from 2003. Specifically, SEC-related expenses and accruals totaled $13.6 million in 2004 compared with $6.9 million in 2003. These expenses and accruals impacted the professional services and other expense

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

categories. Unizan integration planning and systems conversion expenses totaled $3.6 million in 2004 and were none in 2003. In addition to impacting the data processing and other services expense category, a portion of these expenses was also spread across various other expense categories.

2003 versus 2002 Performance

Non-interest expense declined $144.0 million, or 10%, from 2002. Comparisons with prior-period results were significantly influenced by the decline in operating lease expense as previously noted. Operating lease expense declined $125.7 million, or 24%, from 2002. Excluding operating lease expense, non-interest expense declined $18.3 million, or 2%, from 2002 reflecting:

  –  $55.6 million decline in restructuring reserve charges as 2003 reflected a $6.7 million restructuring reserve recovery, compared with $49.0 million of restructuring reserve charges in 2002.
 
  –  $11.3 million decline in other expense including $1.1 million associated with the sold Florida banking and insurance operations, with the remaining $10.2 million decline reflecting lower operational losses, travel costs, and franchise taxes.

Partially offset by:

  –  $29.2 million increase in personnel costs consisting of higher incentive and sales commission expense, especially related to mortgage banking activity, as well as higher benefit and pension costs, partially offset by an $11.5 million decline associated with the sold Florida banking and insurance operations.
 
  –  $15.3 million of expense related to the early extinguishment of long-term debt.
 
  –  $9.4 million, or 28%, increase in professional services including $6.9 million of SEC-related costs.

Operating Lease Assets

(This section should be read in conjunction with the Critical Accounting Policies and Use of Significant Estimates, Significant Factor 1, and the Lease Residual Risk section.)

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

Operating lease assets performance for the five years ended December 31, 2004 was as follows:

Table 10 — Operating Lease Performance

                                             
Year Ended December 31,

(in thousands of dollars) 2004 2003 2002 2001 2000

Balance Sheet:
                                       
 
Average operating lease assets outstanding
  $ 896,773     $ 1,696,535     $ 2,601,666     $ 2,969,902     $ 2,751,058  

Income Statement:
                                       
 
Net rental income
  $ 267,202     $ 458,644     $ 615,453     $ 654,625     $ 596,821  
 
Fees
    13,457       21,623       28,542       27,573       23,511  
 
Recoveries — early terminations
    6,432       9,431       13,079       9,535       3,503  

   
Total operating lease income
    287,091       489,698       657,074       691,733       623,835  

 
Depreciation and residual losses at termination
    216,445       350,550       463,783       506,267       470,079  
 
Losses — early terminations
    20,033       42,720       55,187       52,359       24,721  

   
Total operating lease expense
    236,478       393,270       518,970       558,626       494,800  

 
Net earnings contribution
  $ 50,613     $ 96,428     $ 138,104     $ 133,107     $ 129,035  

Earnings ratios(1)
                                       
 
Net rental income
    29.8 %     27.0 %     23.7 %     22.0 %     21.7 %
 
Depreciation and residual losses at termination
    24.1       20.7       17.8       17.0       17.1  

(1)  As a percent of average operating lease assets.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

2004 versus 2003 Performance

Average operating lease assets in 2004 declined 47% from the prior year as these assets continued to run-off.

The net earnings contribution from operating leases was $50.6 million in 2004, down 48% from $96.4 million in 2003. While both operating lease income and operating lease expense are expected to decline commensurate with the decline in operating lease assets, operating lease income declined more rapidly than operating lease expense. This was because residual value losses have remained elevated on a relative basis, partially due to the fact that losses have exceeded the cap on one of the residual value insurance policies.

Operating lease income, which totaled $287.1 million in 2004, and represented 35% of non-interest income, declined 41% from 2003 reflecting the decline in average operating leases. The majority of this decline was reflected in lower net rental income, down 42% from 2003. Lower fees and recoveries from early terminations also contributed to the decline in total operating lease income, but to a much lesser degree.

Operating lease expense totaled $236.5 million, down 40% from a year ago, also reflecting the continued decline in operating lease assets, with the decline primarily related to lower depreciation and residual losses at termination expenses.

Losses on operating lease assets consist of residual losses at lease termination and losses on early terminations. Residual losses arise if the ultimate value or sales proceeds from the automobile are less than Black Book value, which represents the insured amount under the Company’s residual value insurance policies. This situation may occur due to the results of vehicle remarketing efforts, excess wear-and-tear, excess mileage, or other market value fluctuations. 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.

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

Residual value losses on automobile leases booked prior to October 1, 2000, are covered by an insurance policy with a $120 million cap. During the 2004 third quarter, residual value losses exceeded this cap, resulting in higher operating lease depreciation expense. Total losses above the cap are expected to be $17-$28 million, including $10 million already recognized and reflected in additional accumulated depreciation. The residual value insurance policy covering automobile leases originated between October 1, 2000 and April 30, 2002 contains a $50 million cap. At this time, the Company anticipates that total claims against this policy will be $11-$25 million, well below its cap. To date, approximately $5 million of claims have been filed on this policy.

Credit losses on operating lease assets are included in operating lease expense and were $20.0 million in 2004, down from $42.7 million a year earlier. Recoveries on operating lease assets are included in operating lease income and totaled $6.4 million in 2004, down from $9.4 million a year earlier. The ratio of operating lease asset credit losses to average operating lease assets, net of recoveries, was 1.52% in 2004, down from 1.96% in 2003.

2003 versus 2002 Performance

Average operating lease assets in 2003 declined 35% from 2002. The net earnings contribution from operating leases was $96.4 million in 2003, down from $138.1 million in 2002, a 30% decline. Operating lease income declined $167.4 million, or 25%, from 2002. Operating lease expense declined $125.7 million, or 24%, from the prior year.

The ratio of operating lease asset credit losses to average operating lease assets, net of recoveries, was 1.96% in 2003, up from 1.62% in 2002.

Provision for Income Taxes

The provision for income taxes was $153.7 million in 2004, $138.3 million in 2003 and $199.0 million in 2002. The effective tax rate was 27.8%, 26.4% and 38.1% in 2004, 2003 and 2002, respectively. The higher effective tax rate in 2004 compared with 2003 reflected a reduction in tax benefits (credits) from investments in partnerships and the impact of non-deductible expenses. Tax expense in 2002

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

was significantly impacted by the effect of the strategic refocusing and related sale of the Florida banking and insurance operations. The $60.7 million decrease in income tax expense in 2003 compared with 2002 reflecting the fact that most of the goodwill relating to the Florida banking operations sold in 2002 was non-deductible for income tax purposes.

The cost of investments in low income housing partnerships, along with the related tax credit, is recognized in the financial statements as a component of income taxes under the effective yield method. The cost of the investment in historic property partnerships is reported in non-interest expense and the related tax credit is recognized in the financial statements as a component of income taxes.

In accordance with FAS 109, Accounting for Income Taxes, no deferred taxes are to be recorded when a company intends to permanently reinvest its earnings from a foreign activity. As of December 31, 2004, the Company intended to permanently reinvest the earnings from its foreign asset securitization activities of approximately $89.0 million. (See Note 2 of the Notes to Consolidated Financial Statements.)

In the ordinary course of business, the Company operates in various taxing jurisdictions and is subject to income and non-income taxes. The effective tax rate is based in part on Management’s interpretation of the relevant current tax laws. Management believes the aggregate liabilities related to taxes are appropriately reflected in the consolidated financial statements. During 2003, the Internal Revenue Service advised the Company that the audit of the consolidated federal income tax returns was completed through tax year 2001. The Company was advised in December 2004 that the audit of the consolidated federal income tax returns for tax years 2002 and 2003 would begin in March 2005.

Management expects the 2005 effective tax rate to remain below 30% as the level of tax-exempt income, general business credits, and asset securitization activities remain consistent with prior years. (See Note 17 of the Notes to Consolidated Financial Statements.)

RISK MANAGEMENT

Risk identification and monitoring are key elements in the overall risk management of Huntington. Management believes the primary risk exposures are credit, market, and liquidity risk. Credit risk is the risk of loss due to adverse changes in the borrower’s ability to meet its financial obligations under agreed upon terms. Market risk represents the risk of loss due to changes in the market value of assets and liabilities due to changes in interest rates, exchange rates, residual values and equity prices. Liquidity risk arises from the possibility that funds may not be available to satisfy current or future commitments based on external macro market issues, investor perception of financial strength, and events unrelated to the Company such as war, terrorism, or financial institution market specific issues.

Management follows a formal policy to identify, measure, and document the key risks facing the Company, how those risks can be controlled or mitigated, and how Management monitors the controls to ensure that they are effective. Huntington’s Internal Audit department performs ongoing independent reviews of the risk management process and ensures the adequacy of documentation. The results of these reviews are reported regularly to the Audit Committee of the Board of Directors. Huntington’s Chief Risk Officer is responsible for ensuring that appropriate systems of controls are in place for managing and monitoring risk across the Company.

Some of the more significant processes used to manage and control credit, market and liquidity risks are described in the following paragraphs.

Credit Risk

Credit risk is the risk of loss due to adverse changes in a borrower’s ability to meet its financial obligations under agreed upon terms. The Company is subject to credit risk in lending, trading, and investment activities. The nature and degree of credit risk is a function of the types of transactions, the structure of those transactions, and the parties involved. The majority of the Company’s credit risk is associated with lending activities, as the acceptance and management of credit risk is central to profitable lending. Credit risk is incidental to trading activities and represents a limited portion of the total risks associated with the investment portfolio. Credit risk is mitigated through a combination of credit policies and processes and portfolio diversification. These include origination/underwriting criteria, portfolio monitoring processes, and effective problem asset management.

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

Concentration risk is managed with limits on loan type, geographic and industry diversification, country limits, and loan quality factors. In 2003, the Company increased its emphasis on extending credit to commercial customers with existing or expandable

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

relationships within the Company’s primary markets. As a result, shared national credit exposure declined significantly over this period. The sales of automobile loans are another example of the proactive management of concentration risk. (See Significant Factor 4.)

The checks and balances in the credit process and the independence of the credit administration and risk management functions are designed to minimize problems and to facilitate the early recognition of problems when they do occur.

Commercial Credit

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

Commercial and industrial loan commitments and balances outstanding by industry classification code as of December 31, 2004, were as follows:

Table 11 — Commercial and Industrial Loans by Industry Classification Code(1)

                                     
At December 31, 2004

 Commitments  Loans Outstanding


(in thousands of dollars) Amount % Amount %

Industry Classification:
                               
 
Services
    $ 2,351,512       23.5 %     $1,495,593       25.7 %
 
Manufacturing
    1,920,759       19.2       1,032,576       17.7  
 
Retail trade
    1,824,125       18.2       1,215,671       20.9  
 
Finance, insurance, and real estate
    1,560,404       15.6       792,147       13.6  
 
Contractors and construction
    805,445       8.0       377,841       6.5  
 
Wholesale trade
    766,071       7.7       461,297       7.9  
 
Transportation, communications, and utilities
    482,521       4.8       244,625       4.2  
 
Agriculture and forestry
    140,415       1.4       96,210       1.7  
 
Energy
    99,535       1.0       67,318       1.2  
 
Public administration
    18,886       0.2       13,298       0.2  
 
Other
    38,621       0.4       33,109       0.4  

   
Total
    $10,008,294       100.0 %     $5,829,685       100.0 %

(1)  Includes middle market and small business C&I loans.

All C&I and CRE credit extensions are assigned internal risk ratings reflecting the borrower’s probability-of-default and loss-in-event-of-default. This two-dimensional rating methodology, which has 192 individual loan grades, was implemented in 2003 and has provided granularity in the portfolio management process. The probability-of-default is rated on a scale of 1-12 and is applied at the borrower level. The loss-in-event-of-default is rated on a 1-16 scale and is associated with each individual credit exposure based on the type of credit extension and the underlying collateral.

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

In addition to the initial credit analysis initiated by the portfolio manager during the underwriting process, the loan review group performs independent credit reviews. The loan review group reviews individual loans and credit processes, and conducts a portfolio review at each of the regions on a 15-month cycle. During the previous 15 months, approximately 61% of the total commercial portfolio was reviewed by the independent loan review function.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

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

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

Consumer Credit

Consumer credit approvals are based on, among other factors, the financial strength of the borrower, type of exposure, transaction structure, and the general economic outlook. Consumer credit decisions are generally made in a centralized environment utilizing decision models. There is also individual credit authority granted to certain individuals on a regional basis to preserve the Company’s local decision-making focus. Each credit extension is assigned a specific probability-of-default and loss-in-event-of-default. The probability-of-default is generally a function of the borrower’s credit bureau score, while the loss-in-event-of-default is related to the type of collateral and the loan-to-value ratio associated with the credit extension.

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

Collection action is initiated on an “as needed” basis through a centrally managed collection and recovery function. The collection group employs a series of collection methodologies designed to maintain a high level of effectiveness while maximizing efficiency. In addition to the retained consumer loan portfolio, the collection group is responsible for collection activity on all sold and securitized loans and leases.

Non-Performing Assets (NPAs)

(This section should be read in conjunction with Significant Factor 4.)

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. C&I, CRE, and small business 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. 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 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 collateral. When, in Management’s judgment, the borrower’s ability and intent to make periodic interest and principal payments resume and collectibility is no longer in doubt, the loan is returned to accrual status. A charge-off on a residential mortgage loan 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, less the cost to sell, is then recorded as real estate owned.

At September 30, 2004, the Company adopted a new policy of placing home equity loans and lines on non-accrual status when they exceed 180 days past due. Such loans were previously classified as accruing loans and leases past due 90 days or more. This policy change conforms the home equity loans and lines classification to that of other consumer loans secured by residential real estate.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

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

                                             
At December 31,

(in thousands of dollars) 2004 2003 2002 2001 2000

Non-accrual loans and leases:
                                       
 
Middle market commercial and industrial
  $ 24,179     $ 33,745     $ 79,691     $ 143,140     $ 40,174  
 
Middle market commercial real estate
    4,582       18,434       19,875       35,848       17,462  
 
Small business commercial and industrial and commercial real estate
    14,601       13,607       19,060       29,009       24,870  
 
Residential mortgage
    13,545       9,695       9,443       11,836       10,174  
 
Home equity(1)
    7,055                          

Total non-accrual loans and leases
    63,962       75,481       128,069       219,833       92,680  
Renegotiated loans
                      1,276       1,304  

Total non-performing loans and leases
    63,962       75,481       128,069       221,109       93,984  
Other real estate, net:
                                       
 
Residential
    8,762       6,918       7,915       4,915       3,641  
 
Commercial(2)
    35,844       4,987       739       1,469       7,772  

   
Total other real estate, net
    44,606       11,905       8,654       6,384       11,413  

Total non-performing assets
  $ 108,568     $ 87,386     $ 136,723     $ 227,493     $ 105,397  

Non-performing loans and leases as a % of total loans and leases
    0.27 %     0.36 %     0.69 %     1.20 %     0.53 %
Non-performing assets as a % of total loans and leases and other real estate
    0.46       0.41       0.74       1.23       0.60  
Allowances for credit losses (ACL) as % of:
                                       
 
Non-performing loans and leases
    476       444       263       167       282  
 
Non-performing assets
    280       384       246       162       251  
Accruing loans and leases past due 90 days or more(1)
  $ 54,283     $ 55,913     $ 61,526     $ 76,013     $ 66,665  
Accruing loans and leases past due 90 days or more as a percent of total loans and leases
    0.23 %     0.27 %     0.33 %     0.41 %     0.38 %

(1)  As of September 30, 2004, the Company adopted a policy, consistent with its policy for residential mortgage loans, of placing home equity loans and lines on non-accrual status when they become greater than 180 days past due.
 
(2)  At December 31, 2004, other real estate owned included $35.7 million of properties that relate to the work-out of $5.9 million of mezzanine loans. These properties are subject to $29.8 million of non-recourse debt to another financial institution. Both properties are in contract for sale in the first half of 2005.

Total NPAs were $108.6 million at December 31, 2004, up $21.2 million, or 24%, from $87.4 million at December 31, 2003, but down 21% from $136.7 million at the end of 2002. Expressed as a percent of total loans and leases and other real estate, the year-end positions for 2004, 2003, and 2002 were 0.46%, 0.41%, and 0.74%, respectively. (See Table 12.)

Table 13 — Non-Performing Asset Activity

                                         
Year Ended December 31,

(in thousands of dollars) 2004 2003 2002 2001 2000

Non-performing assets, beginning of period
  $ 87,386     $ 136,723     $ 227,493     $ 105,397     $ 98,241  
New non-performing assets(1)(2)
    137,359       222,043       260,229       329,882       112,319  
Returns to accruing status
    (3,795 )     (16,632 )     (17,124 )     (2,767 )     (5,914 )
Loan and lease losses
    (37,337 )     (109,905 )     (152,616 )     (67,491 )     (18,052 )
Payments
    (43,319 )     (83,886 )     (136,774 )     (106,889 )     (67,431 )
Sales
    (31,726 )     (60,957 )     (44,485 )     (30,639 )     (13,766 )

Non-performing assets, end of period
  $ 108,568     $ 87,386     $ 136,723     $ 227,493     $ 105,397  

(1)  As of September 30, 2004, the Company adopted a policy, consistent with its policy for residential mortgage loans, of placing home equity loans and lines on nonaccrual status when they become greater than 180 days past due.
 
(2)  At December 31, 2004, other real estate owned included $35.7 million of properties that relate to the work-out of $5.9 million of mezzanine loans. These properties are subject to $29.8 million of non-recourse debt to another financial institution. Both properties are in contract for sale in the first half of 2005.

All of the increase from the end of 2003 related to the workout of a troubled mezzanine financing relationship. During the 2004 fourth quarter, OREO reflected a $35.7 million increase for properties related to the workout of $5.9 million of non-performing mezzanine loans to a real estate partnership as the Company took ownership of the partnership, which required consolidation of the partnership’s assets and liabilities including these properties. These properties are subject to $29.8 million of non-recourse debt to another financial institution, and are in contract for sale early in 2005 at their current book value.

The decline in 2003 from the end of 2002, reflected success at aggressively exiting troubled and lower credit quality C&I and CRE credits.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Allowances for Credit Losses

(This section should be read in conjunction with Significant Factors 1, 4 and 8.)

The Company maintains two reserves, both of which are available to absorb probable credit losses: the allowance for loan and lease losses (ALLL) and the allowance for unfunded loan commitments and letters of credit (AULC). When summed together, these reserves constitute the total allowances for credit losses (ACL). The Credit Administration group is responsible for developing the methodology and determining the adequacy of the ALLL and AULC.

The ALLL represents the estimate of probable losses inherent in the loan portfolio at the balance sheet date. Additions to the ALLL result from recording provision expense for loan losses, while reductions reflect charge-offs, recoveries, or the sale of loans.

PROCESS TO DETERMINE THE ADEQUACY OF THE ALLL

Management has an established process to determine the adequacy of the ALLL that relies on a number of analytical tools and benchmarks. No single statistic or measurement, in itself, determines the adequacy of the allowance. For determination purposes, the allowance is comprised of three components: the transaction reserve, specific reserve, and the economic reserve.

    Transaction Reserve
  The transaction reserve component represents an estimate of loss based on characteristics of each commercial and consumer loan or lease in the portfolio. Each loan and lease is assigned a probability-of-default and a loss-in-event-of-default factor that are used to calculate the transaction reserve.
 
  For middle market commercial and industrial, middle market commercial real estate, and small business loans, the calculation involves the use of a standardized loan grading system that is applied on an individual loan level and updated on a continuous basis. The reserve factors applied to these portfolios were developed based on internal credit migration models that track historical movements of loans between loan ratings over time and a combination of long-term average loss experience of the Company’s own portfolio and external industry data.
 
  In the case of more homogeneous portfolios, such as consumer loans and leases, and residential mortgage loans, the determination of the transaction component is conducted at an aggregate, or pooled, level. For such portfolios, the development of the reserve factors includes the use of forecasting models to measure inherent loss in these portfolios.
 
  Models and analyses are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in the loss mitigation or credit origination strategies. Adjustments to the reserve factors are made as needed based on observed results of the portfolio analytics.

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

    Economic Reserve
  Changes in the economic environment are a significant judgmental factor management considers in determining the appropriate level of the ACL. The economic reserve incorporates Management’s determination of the impact of risks associated with the general economic environment on the portfolio. The economic reserve is designed to address economic uncertainties and is determined based on a variety of economic factors that are correlated to the historical performance of the loan portfolio. Because of this more quantitative approach to recognizing risks in the general economy, the economic reserve may fluctuate from period-to-period.
 
  In an effort to be as quantitative as possible in the ALLL calculation, Management developed a revised methodology for calculating the economic reserve portion of the ALLL for implementation in 2004. The revised methodology is specifically tied to economic indices that have a high correlation to the Company’s historic charge-off variability. The indices currently in the model consist of the U.S. Index of Leading Economic Indicators, U.S. Profits Index, U.S. Unemployment Index, and the University of Michigan Current Consumer Confidence Index. Beginning in 2004, the calculated economic reserve was determined based upon the variability of credit losses over a credit cycle. The indices and time frame may be adjusted as actual portfolio performance changes over time. Management has the capability to judgmentally adjust the calculated economic reserve amount by a

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

  maximum of +/- 20% to reflect, among other factors, differences in local versus national economic conditions. This adjustment capability is deemed necessary given the newness of the model and the continuing uncertainty of forecasting economic environment changes.

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

PROCESS TO DETERMINE THE ADEQUACY OF THE AULC

The AULC is determined by applying the transaction reserve process to the unfunded portion of the portfolio adjusted by an applicable funding percentage.

Table 14 — Allocation of Allowances for Credit Losses(1)

                                                                                   
At December 31,

(in thousands of dollars) 2004 2003 2002 2001 2000

Commercial:
                                                                               
 
Middle market commercial and industrial
  $ 87,485       19.8 %   $ 103,237       21.0 %   $ 106,998       25.6 %   $ 131,489       26.6 %   $ 63,962       28.5 %
 
Middle market commercial real estate
    54,927       14.9       63,294       15.1       35,658       15.5       43,574       14.8       33,094       14.1  
 
Small business commercial and industrial and commercial real estate
    32,009       9.0       30,455       8.9       26,914       9.1       31,582       14.1       36,246       14.7  

Total commercial
    174,421       43.7       196,986       45.0       169,570       50.2       206,645       55.5       133,302       57.3  

Consumer:
                                                                               
 
Automobile loans and leases
    41,273       18.6       58,375       23.2       51,621       21.1       38,799       16.0       28,877       14.9  
 
Home equity
    29,275       19.3       25,995       17.7       16,878       16.9       24,054       19.0       19,246       11.9  
 
Residential mortgage
    18,995       16.3       11,124       12.0       8,566       9.4       6,013       6.1       4,421       6.0  
 
Other loans
    7,247       2.1       7,252       2.1       8,085       2.4       19,757       3.4       22,516       9.9  

Total consumer
    96,790       56.3       102,746       55.0       85,150       49.8       88,623       44.5       75,060       42.7  

Total unallocated(2)
                            45,783             50,134             38,396        

Total allowance for loan and lease losses
  $ 271,211       100.0 %   $ 299,732       100.0 %   $ 300,503       100.0 %   $ 345,402       100.0 %   $ 246,758       100.0 %

Allowance for unfunded loan commitments and letters of credit
    33,187               35,522               36,145               23,930               18,171          

Total allowances for credit losses
  $ 304,398             $ 335,254             $ 336,648             $ 369,332             $ 264,929          

(1)  Percentages represent the percentage of each loan and lease category to total loans and leases.
 
(2)  Prior to 2003, the Company maintained an unallocated component of its ALLL. The unallocated component was eliminated in 2003 with the adoption of the more granular risk rating system with most of the prior unallocated reserve absorbed into the transaction reserve.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Table 15 — Summary of Allowances for Credit Losses and Related Statistics

                                               
Year Ended December 31,

(in thousands of dollars) 2004 2003 2002 2001 2000

Balance, beginning of year
  $ 299,732     $ 300,503     $ 345,402     $ 246,758     $ 255,642  
Loan and lease losses
                                       
Commercial
                                       
 
Middle market commercial and industrial
    (21,095 )     (86,217 )     (112,430 )     (48,788 )     (9,609 )
 
Middle market real estate:
                                       
   
Construction
    (2,477 )     (3,092 )     (4,343 )     (824 )     (218 )
   
Commercial
    (5,650 )     (6,763 )     (13,383 )     (1,959 )     (740 )

     
Total middle market commercial real estate
    (8,127 )     (9,855 )     (17,726 )     (2,783 )     (958 )

 
Small business commercial and industrial and commercial real estate
    (10,270 )     (16,311 )     (18,587 )     (18,693 )     (9,206 )

     
Total commercial
    (39,492 )     (112,383 )     (148,743 )     (70,264 )     (19,773 )

Consumer
                                       
 
Automobile loans and leases
    (57,025 )     (63,522 )     (59,010 )     (71,638 )     (47,687 )
 
Home equity(1)
    (17,514 )     (14,166 )     (13,395 )     (13,201 )     (4,021 )
 
Residential mortgage
    (1,975 )     (915 )     (888 )     (879 )     (1,140 )
 
Other consumer loans(1)
    (10,109 )     (10,548 )     (12,316 )     (18,558 )     (13,204 )

     
Total consumer
    (86,623 )     (89,151 )     (85,609 )     (104,276 )     (66,052 )

     
Total loan and lease losses
    (126,115 )     (201,534 )     (234,352 )     (174,540 )     (85,825 )

Recoveries of loan and lease losses
                                       
Commercial
                                       
 
Middle market commercial and industrial
    19,175       10,414       7,727       3,450       2,650  
 
Middle market real estate:
                                       
   
Construction
    12       164       127       35       219  
   
Commercial
    144       1,744       1,415       539       104  

     
Total middle market commercial real estate
    156       1,908       1,542       574       323  

 
Small business commercial and industrial and commercial real estate
    4,704       4,686       4,071       2,943       1,661  

     
Total commercial
    24,035       17,008       13,340       6,967       4,634  

Consumer
                                       
 
Automobile loans and leases
    17,614       17,528       18,464       16,567       15,407  
 
Home equity(1)
    2,440       2,052       1,555       1,743       142  
 
Residential mortgage
    215       83       16       94       133  
 
Other consumer loans(1)
    3,276       3,054       4,065       2,900       3,862  

     
Total consumer
    23,545       22,717       24,100       21,304       19,544  

     
Total recoveries
    47,580       39,725       37,440       28,271       24,178  

Net loan and lease losses
    (78,535 )     (161,809 )     (196,912 )     (146,269 )     (61,647 )

Provision for credit losses
    55,062       163,993       194,426       257,326       61,464  
Net change in allowance for unfunded loan commitments and letters of credit
    2,335       623       (12,215 )     (5,759 )     118  
Allowance of assets sold and securitized(2)
    (7,383 )     (3,578 )     (30,198 )     (6,654 )     (8,819 )

Allowance for loan and lease losses, end of period
  $ 271,211     $ 299,732     $ 300,503     $ 345,402     $ 246,758  

Allowance for unfunded loan commitments and letters of credit, beginning of period
  $ 35,522     $ 36,145     $ 23,930     $ 18,171     $ 18,289  
Net change
    (2,335 )     (623 )     12,215       5,759       (118 )

Allowance for unfunded loan commitments and letters of credit, end of period
  $ 33,187     $ 35,522     $ 36,145     $ 23,930     $ 18,171  

Balance, end of year
  $ 304,398     $ 335,254     $ 336,648     $ 369,332     $ 264,929  

Net loan and lease losses as a % of average total loans and leases
    0.35 %     0.81 %     1.13 %     0.81 %     0.35 %
Allowances for credit losses as a % of total period end loans and leases
    1.29       1.59       1.81       2.00       1.50  

(1)  Effective December 31, 2004, unsecured personal credit line charge-offs were reclassified from “home equity loans” to “other loans” in all periods presented.
 
(2)  2003 reflects a $10.3 million addition related to adoption of FIN 46.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Prior to the first quarter of 2004, the ALLL included an AULC component. To reflect the nature of this reserve and consistent with better disclosure, in the 2004 first quarter the AULC was reclassified as a separate liability on the balance sheet. This reclassification had no impact on net income, shareholders’ equity, or the amount of total credit reserves.

The table below presents the components of the ACL expressed as a percent of total period end loans and leases as of December 31, 2004 and December 31, 2003:

                   
At December 31,

2004 2003

 
Transaction reserve
    0.78 %     0.88 %
 
Specific reserve
    0.05       0.14  
 
Economic reserve
    0.32       0.40  

Total ALLL
    1.15       1.42  
Total AULC
    0.14       0.17  

Total ACL
    1.29 %     1.59 %

Net Charge-offs

Total net charge-offs as a percent of average total loans and leases were 0.35% in 2004, down from 0.81% in 2003, and 1.13% in 2002. (See Table 16.) The decline from 2003 primarily reflected lower C&I and small business net charge-offs.

Total consumer net charge-offs represented 0.51% of such loans in 2004, down from 0.63% in 2003, and 0.76% in 2002. The primary driver of this improvement was the origination of higher quality automobile loans and leases over this period, as well as the increased significance of residential mortgages in the consumer loan portfolio mix. Total net charge-offs as a percent of average total loans and leases were 0.81% in 2003, down from 1.13% in 2002. The decline from 2002 primarily reflected lower C&I and CRE net charge-offs, both of which were impacted by significant NPA sales in the 2003 and 2002 fourth quarters.

The company has established the following long-term net charge-off ratio targets for certain portfolio segments, and for the total portfolio, assuming a comparable portfolio mix, as well as a stable economic environment:

         
Long-term Targets(1)

Middle market C&I
    0.20% - 0.30%  
Middle market CRE
    0.15% - 0.25%  
Small business
    0.40% - 0.50%  
Automobile loans
    0.75% - 0.85%  
Automobile direct finance leases
    0.50% - 0.60%  
Home equity loans and lines
    0.30% - 0.40%  
Residential loans
    0.10% +/-  
Total loans and leases
    0.35% - 0.45%  

              (1)  Assumes loan and lease portfolio mix comparable to December 31, 2004, and stable economic environment.

Investment Portfolio

Investment decisions that incorporate credit risk require the approval of the independent credit administration function. The degree of initial due diligence and subsequent review is a function of the type, size, and collateral of the investment. Performance is monitored on a regular basis, and reported to the Market Risk Committee (MRC) and the executive credit risk committee.

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED

Table 16 — Net Loan and Lease Charge-offs

                                               
At December 31,

(in thousands of dollars) 2004 2003 2002 2001 2000

Net charge-offs by loan and lease type
                                       
Commercial: