SELECTED FINANCIAL DATA
Exhibit 13.1
HUNTINGTON BANCSHARES INCORPORATED
Table 1 — Selected Financial Data(1)
                                           
    Year Ended December 31,
 
(in thousands of dollars, except per share amounts)   2006   2005   2004   2003   2002
 
 
Interest income
  $ 2,070,519     $ 1,641,765     $ 1,347,315     $ 1,305,756     $ 1,293,195  
 
Interest expense
    1,051,342       679,354       435,941       456,770       543,621  
 
 
Net interest income
    1,019,177       962,411       911,374       848,986       749,574  
 
Provision for credit losses
    65,191       81,299       55,062       163,993       194,426  
 
Net interest income after provision for credit losses
    953,986       881,112       856,312       684,993       555,148  
 
 
Service charges on deposit accounts
    185,713       167,834       171,115       167,840       153,564  
 
Automobile operating lease income
    43,115       133,015       285,431       489,698       657,074  
 
Gain on sales of automobile loans
    3,095       1,211       14,206       40,039        
 
Gain on sale of Florida operations
                            182,470  
 
Securities (losses) gains
    (73,191 )     (8,055 )     15,763       5,258       4,902  
 
Other non-interest income
    402,337       338,277       332,083       366,318       343,694  
 
Total non-interest income
    561,069       632,282       818,598       1,069,153       1,341,704  
 
 
Personnel costs
    541,228       481,658       485,806       447,263       418,037  
 
Automobile operating lease expense
    31,286       103,850       235,080       393,270       518,970  
 
Restructuring reserve (releases) charges
                (1,151 )     (6,666 )     48,973  
 
Other non-interest expense
    428,480       384,312       402,509       396,292       388,167  
 
Total non-interest expense
    1,000,994       969,820       1,122,244       1,230,159       1,374,147  
 
Income before income taxes
    514,061       543,574       552,666       523,987       522,705  
Provision for income taxes
    52,840       131,483       153,741       138,294       198,974  
 
Income before cumulative effect of change in accounting principle
    461,221       412,091       398,925       385,693       323,731  
Cumulative effect of change in accounting principle, net of tax(2)
                      (13,330 )      
 
Net income
  $ 461,221     $ 412,091     $ 398,925     $ 372,363     $ 323,731  
 
Income before cumulative effect of change in accounting
principle per common share — basic
    $  1.95       $  1.79       $  1.74       $  1.68       $  1.34  
Net Income per common share — basic
    1.95       1.79       1.74       1.62       1.34  
Income before cumulative effect of change in accounting
principle per common share — diluted
    1.92       1.77       1.71       1.67       1.33  
Net Income per common share — diluted
    1.92       1.77       1.71       1.61       1.33  
Cash dividends declared
    1.000       0.845       0.750       0.670       0.640  
 
Balance sheet highlights
                                       
 
Total assets (period end)
  $ 35,329,019     $ 32,764,805     $ 32,565,497     $ 30,519,326     $ 27,539,753  
Total long-term debt (period end)(3)
    4,512,618       4,597,437       6,326,885       6,807,979       4,246,801  
Total shareholders’ equity (period end)
    3,014,326       2,557,501       2,537,638       2,275,002       2,189,793  
Average long-term debt(3)
    4,942,671       5,168,959       6,650,367       5,816,660       3,613,527  
Average shareholders’ equity
    2,945,597       2,582,721       2,374,137       2,196,348       2,238,761  
Average total assets
    35,111,236       32,639,011       31,432,746       28,971,701       26,063,281  
 
Key ratios and statistics
                                       
 
Margin analysis — as a % of average earnings assets
                                       
 
Interest income(4)
    6.63 %     5.65 %     4.89 %     5.35 %     6.23 %
 
Interest expense
    3.34       2.32       1.56       1.86       2.61  
 
Net interest margin(4)
    3.29 %     3.33 %     3.33 %     3.49 %     3.62 %
 
 
Return on average total assets
    1.31 %     1.26 %     1.27 %     1.29 %     1.24 %
Return on average total shareholders’ equity
    15.7       16.0       16.8       17.0       14.5  
Efficiency ratio(5)
    59.4       60.0       65.0       63.9       65.6  
Dividend payout ratio
    52.1       47.7       43.9       41.6       48.1  
Average shareholders’ equity to average assets
    8.39       7.91       7.55       7.58       8.59  
Effective tax rate
    10.3       24.2       27.8       26.4       38.1  
Tangible equity to tangible assets (period end)
    6.87       7.19       7.18       6.79       7.22  
Tier 1 leverage ratio
    8.00       8.34       8.42       7.98       8.51  
Tier 1 risk-based capital ratio (period end)
    8.93       9.13       9.08       8.53       8.34  
Total risk-based capital ratio (period end)
    12.79       12.42       12.48       11.95       11.25  
 
Other data
                                       
 
Full-time equivalent employees
    8,081       7,602       7,812       7,983       8,177  
Domestic banking offices
    381       344       342       338       343  
(1)  Comparisons for presented periods are impacted by a number of factors. Refer to the ’Significant Factors Influencing Financial Performance Comparisons’ for additional discussion regarding these key factors.
 
(2)  Due to the adoption of FASB Interpretation No. 46 “Consolidation of Variable Interest Entities.
 
(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.

10


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS
HUNTINGTON BANCSHARES INCORPORATED
INTRODUCTION
Huntington Bancshares Incorporated (we or our) is a multi-state diversified financial holding company organized under Maryland law in 1966 and headquartered in Columbus, Ohio. Through our subsidiaries, we provide full-service commercial and consumer banking services, mortgage banking services, automobile financing, equipment leasing, investment management, trust services, brokerage services, private mortgage insurance, reinsuring credit life and disability insurance, and other insurance and financial products and services. Our banking offices are located in Ohio, Michigan, West Virginia, Indiana, and Kentucky. Certain activities are also conducted in Arizona, Florida, Georgia, Maryland, Nevada, New Jersey, North Carolina, Pennsylvania, South Carolina, Tennessee, and Vermont. We have a foreign office in the Cayman Islands and another in Hong Kong. The Huntington National Bank (the Bank), organized in 1866, is our only bank subsidiary.
The following discussion and analysis provides you with information we believe necessary for understanding our 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.
You should note the following discussion is divided into key segments:
  –  Introduction — Provides overview comments on important matters including risk factors, the now-terminated written regulatory agreement with the Federal Reserve Bank of Cleveland and critical accounting policies and use of significant estimates. These are essential for understanding our performance and prospects.
 
  –  Discussion of Results of Operations — Reviews financial performance. It also includes a Significant Factors Influencing Financial Performance Comparisons section that summarizes key issues helpful for understanding performance trends. Key consolidated balance sheet and income statement trends are also discussed in this section.
 
  –  Risk Management and Capital — Discusses credit, market, and operational risks, including how these are managed, as well as performance trends. It also includes a discussion of liquidity policies, how we fund ourselves, 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 capital requirements.
 
  –  Lines of Business Discussion — Provides an overview of financial performance for each of our major lines of business and provides additional discussion of trends underlying consolidated financial performance.
 
  –  Results for the Fourth Quarter — Provides a discussion of results for the 2006 fourth quarter compared with the year-earlier quarter.
A reading of each section is important for you to understand fully the nature of our 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. These include descriptions of products or services, plans or objectives for future operations, including any proposed or approved 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, the businesses of Huntington and that of any pending or approved acquisition may not be integrated successfully or such integration may take longer to accomplish than expected; the expected cost savings and any revenue synergies from the acquisition may not be fully realized within the expected timeframes; disruption from the acquisition may make it more difficult to maintain relationships with clients, associates, or suppliers; the required governmental approvals of the acquisition may not be obtained on the proposed terms and schedule; if required by the acquisition, Huntington and/or the stockholders of any pending or approved acquisition may not approve the acquisition; changes in economic conditions; movements in interest rates; competitive pressures on product pricing and services; success and timing of other business strategies; the nature, extent, and timing of governmental actions and reforms; and extended disruption of vital infrastructure; and other factors including but not limited to those set forth under the heading “Risk Factors” included in Item 1A of Huntington’s Annual Report on Form 10-K for the year ended December 31, 2006, and other factors described from time to time in Huntington’s other filings with the Securities and Exchange Commission.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
You should understand forward-looking statements to be strategic objectives and not absolute forecasts of future performance. Forward-looking statements speak only as of the date they are made. We assume 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
We, like other financial institutions, are subject to a number of risks, many of which are outside of our direct control, though efforts are made to manage those risks while optimizing returns. Among the risks assumed are: (1) credit risk, which is the risk that loan and lease customers or other counter parties will be unable to perform their contractual obligations, (2) market risk, which is the risk that changes in market rates and prices will adversely affect our financial condition or results of operation, (3) liquidity risk, which is the risk that we 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 “Risk Factors” included in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2006.
Formal Regulatory Supervisory Agreement
On March 1, 2005, we announced entering into a formal written agreement with the Federal Reserve Bank of Cleveland (FRBC), providing for a comprehensive action plan designed to enhance corporate governance, internal audit, risk management, accounting policies and procedures, and financial and regulatory reporting. The agreement called for independent third-party reviews, as well as the submission of written plans and progress reports by Management, and would remain in effect until terminated by the banking regulators. On May 10, 2006, Huntington announced that the FRBC notified Huntington’s board of directors that Huntington had satisfied the provisions of the written agreement dated February 28, 2005, and that the FRBC, under delegated authority of the Board of Governors of the Federal Reserve System, had terminated the written agreement.
Critical Accounting Policies and Use of Significant Estimates
Our 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 us to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in our financial statements. Note 1 of the Notes to Consolidated Financial Statements included in this report lists significant accounting policies we use in the development and presentation of our 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 necessary for an understanding and evaluation of our company, 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. The most significant accounting estimates and their related application are discussed below. 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 — The allowances for credit losses (ACL) is the sum of the allowance for loan and lease losses (ALLL) and the allowance for unfunded loan commitments and letters of credit (AULC). At December 31, 2006, the ACL was $312.2 million. The amount of the ACL was determined by judgments regarding the quality of the loan portfolio and loan commitments. All known relevant internal and external factors that affected loan collectibility were considered. The ACL represents the estimate of the level of reserves appropriate to absorb inherent credit losses in the loan and lease portfolio, as well as unfunded loan commitments. We believe 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 our estimates, additional provision for credit losses could be required, which could adversely affect earnings or financial performance in future periods. At December 31, 2006, the ACL as a percent of total loans and leases was 1.19%. Based on the December 31, 2006 balance sheet, a 10 basis point increase in this ratio to 1.29% would require $25.2 million in additional reserves (funded by additional provision for credit losses), which would have negatively impacted 2006 net income by approximately $16.3 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.

12


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
–  Fair value Measurements — A significant portion of our assets is carried at fair value, including securities, derivatives, mortgage servicing rights (MSRs) and trading assets. Additionally, a smaller portion is carried at the lower of fair value or cost, including held-for-sale loans, while another portion is evaluated for impairment using fair value measurements. At December 31, 2006, approximately $4.8 billion of our assets were recorded at either fair value or at the lower of fair value or cost.
  The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The majority of assets reported at fair value are based on quoted market prices or on internally developed models that utilize independently sourced market parameters, including interest rate yield curves, option volatilities, and currency rates.
 
  We estimate the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When observable market prices do not exist, we estimate fair value. Our valuation methods consider factors such as liquidity and concentration concerns and, for the derivatives portfolio, counterparty credit risk. Other factors such as model assumptions, market dislocations and unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded for a particular position.
  Trading securities and securities available-for-sale
  Substantially all of our securities are valued based on quoted market prices. However, certain securities are less actively traded. These securities do not always have quoted market prices. The determination of their fair value, therefore, requires judgment, as this determination may require benchmarking to similar instruments or analyzing default and recovery rates. Examples include certain collateralized mortgage and debt obligations and high-yield debt securities.
 
  Our derivative positions are valued using internally developed models based on observable market parameters (parameters that are actively quoted and can be validated to external sources) or model values where quoted market prices do not exist, including industry-pricing services.
 
  Loans held-for-sale
  The fair value of loans in the held-for-sale portfolio is generally based on observable market prices of similar instruments. If market prices are not available, fair value is determined using internally developed models, based on the estimated cash flows, adjusted for credit risk. The credit risk adjustment is discounted using a rate that is appropriate for each maturity and incorporates the effects of interest rate changes.
 
  Goodwill and Intangible Assets
  Goodwill and intangible assets represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Goodwill impairment testing is performed at the reporting unit level annually as of September 30th, or more frequently if events or circumstances indicate possible impairment. Fair values of reporting units are determined using a combination of a discounted cash flow analyses based on internal forecasts and market-based valuation multiples for comparable businesses. No impairment was identified as a result of the testing performed during 2006 or 2005. Note 9 to the Consolidated Financial Statements contains additional information regarding goodwill and the carrying values by lines of business.
 
  MSRs and other servicing rights
  MSRs and certain other servicing rights do not trade in an active, open market with readily observable prices. While sales of MSRs occur, the precise terms and conditions are typically not readily available. Therefore, we estimate the fair value of the MSRs on a monthly basis using a third-party valuation software package. Fair value is estimated based upon discounted net cash flows calculated from a combination of loan level data and market assumptions. The valuation software combines loans based on common characteristics that impact servicing cash flows (investor, remittance cycle, interest rate, product type, etc.) in order to project net cash flows.
 
  Market valuation assumptions (including discount rate, servicing costs, etc.) are also populated within the software. Valuation assumptions are periodically reviewed against available market data (e.g., broker surveys) for reasonableness and adjusted if deemed appropriate. The recorded MSR asset balance is adjusted up or down to estimated fair value based upon the final month-end valuation, which utilized the month-end rate curve and prepayment assumptions. Note 5 of the Notes to Consolidated Financial Statements contains an analysis of the impact to the fair value of MSRs resulting from changes in the estimates used by management.

13


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
–  Income Taxes — The calculation of our provision for income taxes is complex and requires the use of estimates and judgments. We have two accruals for income taxes: Our accrued income taxes represent the net estimated amount currently due or to be received from taxing jurisdictions, including any reserve for potential audit issues, and is reported as a component of “accrued expenses and other liabilities” in our consolidated balance sheet; our deferred federal income tax liability represents the estimated impact of temporary differences between how we recognize our assets and liabilities under GAAP, and how such assets and liabilities are recognized under the federal tax code.
  In the ordinary course of business, we operate in various taxing jurisdictions and are subject to income and non-income taxes. The effective tax rate is based in part on our interpretation of the relevant current tax laws. We believe the aggregate liabilities related to taxes are appropriately reflected in the consolidated financial statements. We review the appropriate tax treatment of all transactions taking into consideration statutory, judicial, and regulatory guidance in the context of our tax positions. In addition, we rely on various tax opinions, recent tax audits, and historical experience.
 
  From time to time, we engage in business transactions that may have an effect on our tax liabilities. Where appropriate, we have obtained opinions of outside experts and have assessed the relative merits and risks of the appropriate tax treatment of business transactions taking into account statutory, judicial, and regulatory guidance in the context of its tax position. However, changes to our estimates of accrued taxes can occur due to changes in tax rates, implementation of new business strategies, resolution of issues with taxing authorities regarding previously taken tax positions and newly enacted statutory, judicial, and regulatory guidance. Such changes can affect the amount of our accrued taxes and can be material to our financial position and/or results of operations. The potential impact to our operating results for any of these changes cannot be reasonably estimated.
Pending Acquisition of Sky Financial Group, Inc.
On December 20, 2006, Huntington announced the signing of a definitive agreement to acquire Sky Financial Group, Inc. (Sky Financial) in a stock and cash transaction expected to be valued at approximately $3.5 billion. Sky Financial is a $17.6 billion diversified financial holding company with over 330 banking offices and over 400 ATMs. Sky Financial serves communities in Ohio, Pennsylvania, Indiana, Michigan and West Virginia. Sky’s financial service affiliates include: Sky Bank, commercial and retail banking; Sky Trust, asset management services; and Sky Insurance, retail and commercial insurance agency services.
Under the terms of the agreement, Sky Financial shareholders will receive 1.098 shares of Huntington common stock, on a tax-free basis, and a taxable cash payment of $3.023 for each share of Sky Financial common stock. The merger was unanimously approved by both boards and is expected to close in the third quarter of 2007, pending customary regulatory approvals, as well as approval by both companies’ shareholders.

14


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 2 — Selected Annual Income Statements(1)
                                                                           
    Year Ended December 31,
 
    Change from 2005       Change from 2004    
                 
(in thousands, except per share amounts)   2006   Amount   %   2005   Amount   %   2004   2003   2002
 
 
Interest income
  $ 2,070,519     $ 428,754       26.1 %   $ 1,641,765     $ 294,450       21.9 %   $ 1,347,315     $ 1,305,756     $ 1,293,195  
 
Interest expense
    1,051,342       371,988       54.8       679,354       243,413       55.8       435,941       456,770       543,621  
 
 
Net interest income
    1,019,177       56,766       5.9       962,411       51,037       5.6       911,374       848,986       749,574  
 
Provision for credit losses
    65,191       (16,108 )     (19.8 )     81,299       26,237       47.7       55,062       163,993       194,426  
 
Net interest income after provision for credit losses
    953,986       72,874       8.3       881,112       24,800       2.9       856,312       684,993       555,148  
 
 
Service charges on deposit accounts
    185,713       17,879       10.7       167,834       (3,281 )     (1.9 )     171,115       167,840       153,564  
 
Trust services
    89,955       12,550       16.2       77,405       9,995       14.8       67,410       61,649       62,051  
 
Brokerage and insurance income
    58,835       5,216       9.7       53,619       (1,180 )     (2.2 )     54,799       57,844       62,109  
 
Other service charges and fees
    51,354       7,006       15.8       44,348       2,774       6.7       41,574       41,446       42,888  
 
Bank owned life insurance income
    43,775       3,039       7.5       40,736       (1,561 )     (3.7 )     42,297       43,028       43,123  
 
Automobile operating lease income
    43,115       (89,900 )     (67.6 )     133,015       (152,416 )     (53.4 )     285,431       489,698       657,074  
 
Mortgage banking
    41,491       13,158       46.4       28,333       1,547       5.8       26,786       58,180       32,751  
 
Gain on sales of automobile loans
    3,095       1,884       N.M.       1,211       (12,995 )     (91.5 )     14,206       40,039        
 
Securities (losses) gains
    (73,191 )     (65,136 )     N.M.       (8,055 )     (23,818 )     N.M.       15,763       5,258       4,902  
 
Gain on sale of Florida operations
                                                    182,470  
 
Other
    116,927       23,091       24.6       93,836       (5,381 )     (5.4 )     99,217       104,171       100,772  
 
Total non-interest income
    561,069       (71,213 )     (11.3 )     632,282       (186,316 )     (22.8 )     818,598       1,069,153       1,341,704  
 
 
Personnel costs
    541,228       59,570       12.4       481,658       (4,148 )     (0.9 )     485,806       447,263       418,037  
 
Outside data processing and other services
    78,779       4,141       5.5       74,638       2,523       3.5       72,115       66,118       67,368  
 
Net occupancy
    71,281       189       0.3       71,092       (4,849 )     (6.4 )     75,941       62,481       59,539  
 
Equipment
    69,912       6,788       10.8       63,124       (218 )     (0.3 )     63,342       65,921       68,323  
 
Marketing
    31,728       5,449       20.7       26,279       1,679       6.8       24,600       25,648       26,655  
 
Automobile operating lease expense
    31,286       (72,564 )     (69.9 )     103,850       (131,230 )     (55.8 )     235,080       393,270       518,970  
 
Professional services
    27,053       (7,516 )     (21.7 )     34,569       (2,307 )     (6.3 )     36,876       42,448       33,085  
 
Telecommunications
    19,252       604       3.2       18,648       (1,139 )     (5.8 )     19,787       21,979       22,661  
 
Printing and supplies
    13,864       1,291       10.3       12,573       110       0.9       12,463       13,009       15,198  
 
Amortization of intangibles
    9,962       9,133       N.M.       829       12       1.5       817       816       2,019  
 
Restructuring reserve (releases) charges
                            1,151       N.M.       (1,151 )     (6,666 )     48,973  
 
Other
    106,649       24,089       29.2       82,560       (14,008 )     (14.5 )     96,568       97,872       93,319  
 
Total non-interest expense
    1,000,994       31,174       3.2       969,820       (152,424 )     (13.6 )     1,122,244       1,230,159       1,374,147  
 
Income before income taxes
    514,061       (29,513 )     (5.4 )     543,574       (9,092 )     (1.6 )     552,666       523,987       522,705  
Provision for income taxes
    52,840       (78,643 )     (59.8 )     131,483       (22,258 )     (14.5 )     153,741       138,294       198,974  
 
Income before cumulative effect of change in accounting principle
    461,221       49,130       11.9       412,091       13,166       3.3       398,925       385,693       323,731  
Cumulative effect of change in accounting principle, net of tax(2)
                                                    (13,330 )      
 
Net income
  $ 461,221     $ 49,130       11.9 %   $ 412,091     $ 13,166       3.3 %   $ 398,925     $ 372,363     $ 323,731  
 
Average common shares — basic
    236,699       6,557       2.8 %     230,142       229       0.1 %     229,913       229,401       242,279  
Average common shares — diluted
    239,920       6,445       2.8       233,475       (381 )     (0.2 )     233,856       231,582       244,012  
Per common share:
                                                                       
 
Income before cumulative effect of change in accounting principle — basic
    $  1.95       $  0.16       8.9 %     $  1.79       $  0.05       2.9 %     $  1.74       $  1.68       $  1.34  
 
Net income — basic
    1.95       0.16       8.9       1.79       0.05       2.9       1.74       1.62       1.34  
 
 
Income before cumulative effect of change in accounting principle — diluted
    1.92       0.15       8.5       1.77       0.06       3.5       1.71       1.67       1.33  
 
Net income — diluted
    1.92       0.15       8.5       1.77       0.06       3.5       1.71       1.61       1.33  
 
 
Cash dividends declared
    1.000       0.16       18.3       0.845       0.10       12.7       0.750       0.670       0.640  
Revenue — fully taxable equivalent (FTE)                                                                
  Net interest income   $ 1,019,177     $ 56,766       5.9 %   $ 962,411     $ 51,037       5.6 %   $ 911,374     $ 848,986     $ 749,574  
  FTE adjustment     16,025       2,632       19.7       13,393       1,740       14.9       11,653       9,684       5,205  
 
Net interest income(3)
    1,035,202       59,398       6.1       975,804       52,777       5.7       923,027       858,670       754,779  
Non-interest income
    561,069       (71,213 )     (11.3 )     632,282       (186,316 )     (22.8 )     818,598       1,069,153       1,341,704  
 
Total revenue(3)
  $ 1,596,271     $ (11,815 )     (0.7 )%   $ 1,608,086     $ (133,539 )     (7.7 )%   $ 1,741,625     $ 1,927,823     $ 2,096,483  
 
N.M., not a meaningful value.
(1)  Comparisons for presented periods are impacted by a number of factors. Refer to the ‘Significant Factors Influencing Financial Performance Comparisons’ for additional discussion regarding these key factors.
 
(2)  Due to adoption of FASB Interpretation No. 46 for variable interest entities.
 
(3)  On a fully taxable equivalent (FTE) basis assuming a 35% tax rate.

15


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
DISCUSSION OF RESULTS OF OPERATIONS
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 are 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
2006 versus 2005
Earnings for full-year 2006 were $461.2 million, or $1.92 per common share, up 12% and 8%, respectively, compared with $412.1 million, or $1.77 per common share, in 2005. The $49.1 million increase in net income primarily reflected:
  –  $78.6 million decline in income tax expense as the effective tax rate for 2006 was 10.3%, down from 24.2% in 2005. The lower 2006 income tax expense reflected the favorable impact of an $84.5 million reduction related to the resolution of a federal income tax audit covering tax years 2002 and 2003 that resulted in the release of federal income tax reserves, as well as the recognition of federal tax loss carry backs. The 2005 effective tax rate of 24.2% was favorably impacted by a combination of factors including the benefit of a federal tax loss carry back, partially offset by the net impact of repatriating foreign earnings.
 
  –  $56.8 million, or 6%, increase in net interest income, reflecting a 7% increase in average earning assets, as the net interest margin of 3.29% declined 4 basis points from 3.33% in the prior year. The increase in average earning assets reflected 7% growth in average total loans and leases, including 12% growth in average total commercial loans and 3% growth in average total consumer loans, and a 15% increase in average investment securities. Growth in earning assets was positively impact by the acquisition of Unizan Financial Corp. (“Unizan”) on March 1, 2006.
 
  –  A $16.1 million decline in provision for credit losses, reflecting overall net improvement in our credit risk performance as reflected in a decline in our allowance for credit losses as a percent of period end loans and leases to 1.04% at December 31, 2006, from 1.10% at the end of 2005.
Partially offset by:
  –  $71.2 million, or 11%, decline in non-interest income. Contributing to the decrease was an $89.9 million expected decline in operating lease income, and a $65.1 million increase in securities losses, reflecting the impact of a balance sheet restructuring in late 2006. Partially offsetting these negative factors were increases in several other components of non-interest income, primarily due to the Unizan acquisition, including a $23.1 million increase in other income, a $17.9 million increase in service charges on deposit accounts, a $13.2 million increase in mortgage banking income, a $12.6 million increase in trust services income, a $7.0 million increase in other service charges and fees, a $5.2 million increase in brokerage and insurance income, and a $1.9 million increase in gains on sales of automobile loans.
 
  –  $31.2 million, or 3%, increase in non-interest expense, reflecting increases in several components of non-interest expense, primarily related to the acquisition of Unizan, including a $59.6 million increase in personnel costs, a $24.1 million increase in other expense, a $9.1 million increase in amortization of intangibles, a $6.8 million increase in equipment expense, a $5.4 million increase in marketing expense, and a $4.1 million increase in outside data processing and other services, partially offset by a $72.6 million expected decrease in operating lease expense and a $7.5 million decline in professional services.
Compared with 2005, the ROA for 2006 was 1.31%, up from 1.26%, and the ROE was 15.7%, down slightly from 16.0%.
Full-year 2006 earnings were impacted by a number of significant items, the largest of which were (1) the acquisition of Unizan Financial Corp. on March 1, 2006, (2) a reduction in federal income tax expense, and (3) a balance sheet restructuring, undertaken to utilize the excess capital resulting from the reduction of federal income tax expense. The details of these impacts can be found in the detailed discussions that follow and are critical to understanding 2006 performance.

16


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
2005 versus 2004
Earnings for 2005 were $412.1 million, or $1.77 per common share, up 3% and 4%, respectively, from $398.9 million, or $1.71 per common share, in 2004. The $13.2 million increase in net income primarily reflected:
  –  $152.4 million, or 14%, decline in non-interest expense, primarily reflecting a $131.2 million decline in operating lease expenses, a $9.9 million decline in SEC-related expenses, a $4.8 million decline in net occupancy expense, a $4.1 million decline in personnel costs, and a $2.9 million decline in Unizan system conversion expenses.
 
  –  $51.0 million, or 6%, increase in net interest income, reflecting a 6% increase in average earning assets, as the net interest margin of 3.33% was unchanged from the prior year. The increase in average earning assets reflected 10% growth in average total loans and leases, including 11% growth in average total consumer loans and 8% growth in average total commercial loans, partially offset by a 14% decline in average investment securities.
 
  –  $22.3 million decline in income tax expense as the effective tax rate for 2005 was 24.2%, down from 27.8% in 2004. The lower 2005 income tax expense reflected a combination of factors including the benefit of a federal tax loss carry back, partially offset by the net impact of repatriating foreign earnings.
Partially offset by:
  –  $186.3 million, or 23%, decline in non-interest income. Contributing to the decrease were a $152.4 million decline in operating lease income, a $23.8 million decline in securities gains as the current year had $8.1 million of securities losses and the prior year had $15.8 million of securities gains, a $13.0 million decline in gains on sales of automobile loans, a $5.4 million decline in other income, and a $3.3 million decline in service charges on deposit accounts. These declines were partially offset by a $10.0 million increase in trust services income and a $2.8 million increase in other service charges and fees.
 
  –  $26.2 million, or 48%, increase in the provision for credit losses, reflecting higher levels of non-performing assets and problem credits, as well as growth in the loan portfolio.
The ROA and ROE for 2005 were 1.26% and 16.0%, respectively, down slightly from 1.27% and 16.8%, respectively, in 2004.
Results of Operations
Significant Factors Influencing Financial Performance Comparisons
Earnings comparisons from 2004 through 2006 were impacted by a number of factors; some related to changes in the economic and competitive environment, while others reflected specific management strategies or changes in accounting practices. Those key factors are summarized below.
    1.  Unizan acquisition. — The merger with Unizan Financial Corp. (Unizan) was completed on March 1, 2006. At the time of acquisition, Unizan had assets of $2.5 billion, including $1.6 billion of loans and core deposits of $1.5 billion. Unizan results were only in consolidated results for 10 months of 2006. As a result, performance comparisons between 2006 and 2005 are affected, as Unizan results were not in 2005 results. Comparisons of 2006 reported results compared with 2005 pre-merger results are impacted as follows:
  –  Increased certain reported period-end balance sheet and credit quality items (e.g., non-performing loans).
 
  –  Increased reported average balance sheet, revenue, expense, and credit quality results (e.g., net charge-offs).
 
  –  Increased reported non-interest expense items as a result of costs incurred as part of merger-integration activities, most notably employee retention bonuses, outside programming services related to systems conversions, and marketing expenses related to customer retention initiatives. Merger costs were $3.7 million for 2006, $0.7 million for 2005, and $3.6 million for 2004.
    Given the impact of the merger on reported 2006 results, we believe that an understanding of the impacts of the merger is necessary to understand better underlying performance trends. When comparing post-merger period results to pre-merger periods, two terms relating to the impact of the Unizan merger on reported results are used:
  –  “Merger-related” refers to amounts and percentage changes representing the impact attributable to the merger.
 
  –  “Merger costs” represent expenses associated with merger integration activities.

17


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
    An analysis reflecting the estimated impact of the Unizan merger on our reported average balance sheet and income statement can be found in Table 30 — Estimated Impact of Unizan Merger.
    2.  Mortgage servicing rights (MSRs) and related hedging. — MSR values are very sensitive to movements in interest rates as 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 when mortgage interest rates rise.
  –  Prior to 2006, we recognized impairment when our valuation of MSRs was less than the recorded book value. We recognized temporary impairment due to changes in interest rates through a valuation reserve and recorded a direct write-down of the book value of MSRs for other-than-temporary declines in valuation. Changes and fluctuations in interest rate levels between quarters resulted in some quarters reporting an MSR temporary impairment, with others reporting a recovery of previously recognized MSR temporary impairment. Such swings in MSR valuations have significantly impacted quarterly mortgage banking income trends throughout this period.
 
  –  Beginning in 2006, we adopted Statement of Financial Accounting Standards (Statement) No. 156, Accounting for Servicing of Financial Assets (an amendment of FASB Statement No. 140), which allowed us to carry MSRs at fair value. This resulted in a $5.1 million pre-tax ($0.01 per common share) positive impact in 2006. Under the fair value approach, servicing assets and liabilities are recorded at fair value at each reporting date. Changes in fair value between reporting dates are recorded as an increase or decrease in mortgage banking income. MSR assets are included in other assets. (See Tables 3, 6, and 7.)
 
  –  Prior to 2005, we used investment securities gains/(losses) as a balance sheet hedge to offset MSR valuation changes. Such gains/(losses) were reported as securities gains/(losses). Beginning in 2005, we used trading account securities and derivatives to offset MSR valuation changes. The valuations of trading securities and derivatives that we use generally react to interest rate changes in an opposite direction compared with changes in MSR valuations. As a result, changes in interest rate levels that impact MSR valuations should result in corresponding offsetting, or partially offsetting, trading gains or losses. As such, in quarters where MSR fair values decline, the fair values of trading account securities and derivatives typically increase, resulting in a recognition of trading gains that offset, or partially offset, the decline in fair value recognized for the MSR, and vice versa. Such trading gains or losses are also recorded as an increase or decrease in mortgage banking income. Net interest income on securities used to hedge MSRs is recorded in interest income.
    3.  Automobile leases originated through April 2002 are accounted for as automobile 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. Automobile operating leases are carried in other assets with the related rental income, other revenue, and credit recoveries reflected as automobile 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 automobile operating lease expense, a component of non-interest expense. With no new automobile operating leases originated since April 2002, the automobile operating lease assets have declined rapidly since then. The level of automobile operating lease assets and related automobile operating lease income and expense declined to a point of diminished materiality by the end of 2006. However, since automobile 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 revenue, total non-interest income, and total non-interest expense trends.
    In contrast, automobile leases originated since April 2002 are accounted for as direct financing leases, an interest earning asset included in total loans and leases with the related income reflected as interest income and included in the calculation of the net interest margin. Credit charge-offs and recoveries are reflected in the allowance for loan and lease losses (ALLL), with related changes in the ALLL reflected in the provision for credit losses. To better understand overall trends in automobile lease exposure, it is helpful to compare trends in the combined total of direct financing leases plus automobile operating leases.
    4.  Effective tax rate. — Various items impacted the effective tax rate for 2006 and 2005. For 2006, impacts included an $84.5 million ($0.35 per common share) reduction of federal income tax expense from the release of tax reserves as a result of the resolution of the federal income tax audit for 2002 and 2003, and the recognition of a federal tax loss carry back. For 2005, federal income tax expense benefited by $26.9 million ($0.12 per common share) from the positive impact of a federal tax loss carry-back, partially offset by a $5.0 million after tax ($0.02 per common share) increase in tax expense from the repatriation of foreign earnings.

18


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
    5.  Share-based compensation. — In 2006, we adopted Statement No. 123R, Share-Based Payment, which resulted in recognizing as personnel expense, the impact of share-based compensation, primarily in the form of stock option grants. Adoption of stock option expensing added $18.6 million, pre-tax, to personnel expense in 2006. (See Note 19 to the Consolidated Financial Statements.)
 
    6.  Balance sheet restructuring. — In 2006, we utilized the excess capital resulting from the favorable resolution to certain federal income tax audits to restructure certain under-performing components of the balance sheet. We believe that these actions will benefit the net interest margin in future periods. Our actions included the review of $2.1 billion of securities for potential sale, the refinancing of a portion of our FHLB funding, and the sale of approximately $100 million of residential mortgage loans. The review of securities for sale resulted in an initial impairment of $57.5 million, which was recorded as a securities loss. The completion of this review resulted in an additional $9.0 million of securities losses, as well as $6.8 million of other than temporary impairment on certain sub-prime mortgage backed securities not included in the initial review. Total securities losses as a result of these actions totaled $73.3 million. The refinancing of FHLB funding and the sale of mortgage loans resulted in total charges of $4.4 million, resulting in total balance sheet restructuring costs of $77.7 million ($0.21 per common share).
 
    7.  Other significant items influencing earnings performance comparisons.
    2006
  –  $10.0 million pre-tax contribution to the Huntington Foundation.
 
  –  $7.4 million pre-tax equity investment gains.
 
  –  $5.5 million pre-tax increase in automobile lease residual value losses. This increase reflected higher relative losses on certain vehicles sold at auction, most notably high-line imports and larger sport utility vehicles.
 
  –  $4.8 million in severance and consolidation expenses, pre-tax. This reflected fourth quarter severance-related expenses associated with a reduction of 75 Regional Banking staff positions, as well as costs associated with the previously announced retirements of a vice chairman and an executive vice president.
 
  –  $3.3 million pre-tax gain on the sale of MasterCard® stock.
 
  –  $3.2 million pre-tax negative impact associated with the write-down of equity method investments.
 
  –  $2.3 million pre-tax unfavorable impact due to a cumulative adjustment to defer home equity annual fees.
    2005
  –  $8.8 million pre-tax investment securities losses, resulting from our decision to reduce our exposure to certain unsecured federal agency securities.
 
  –  $6.5 million pre-tax impact to provision expense associated with the charge-off of a single large commercial credit.
 
  –  $5.1 million of pre-tax severance and consolidation expenses associated with the consolidation of certain operations functions, including the closing of an item-processing center in Michigan. This item increased non-interest expense.
 
  –  $3.7 million pre-tax expense associated with the now-closed SEC investigation and regulatory-related written agreements.
 
  –  $2.6 million pre-tax write-offs of equity investments. This item lowered non-interest income.
    2004
  –  $14.2 million pre-tax gain on the sale of automobile loans associated with the objective of lowering total credit exposure to this sector.
 
  –  $13.6 million pre-tax expense associated with the now-closed SEC investigation and regulatory-related written agreements.
 
  –  $11.1 million pre-tax reduction to provision expense, reflecting a recovery of a single large commercial credit previously charged-off in 2002.
 
  –  $7.8 million pre-tax property lease impairments. This item increased non-interest expense.

19


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
  –  $3.7 million pre-tax one-time funding cost adjustment for a securitization structure consolidated in a prior period, which lowered interest expense and increased net interest income, as well as the net interest margin.
Table 3 — Significant Items Influencing Earnings Performance Comparison(1)
                                                   
    2006   2005   2004
 
(in thousands of dollars)   After-tax   EPS   After-tax   EPS   After-tax   EPS
 
Net income — GAAP
  $ 461,221             $ 412,091             $ 398,925          
Earnings per share, after tax
          $ 1.92             $ 1.77             $ 1.71  
 
Change from prior year — $
            0.15               0.06               0.10  
 
Change from prior year — %
            8.5 %             3.5 %             6.2 %
Significant items — favorable (unfavorable) impact:
    Earnings (2 )     EPS       Earnings (2 )     EPS       Earnings (2 )     EPS  
 
Reduction to federal income tax expense(3)
  $ 84,541     $ 0.35     $     $     $     $  
Equity investment gains
    7,436       0.02                          
MSR FAS 156 accounting change
    5,143       0.01                          
Gain on sale of MasterCard stock
    3,341       0.01                          
Balance sheet restructuring
    (77,698 )     (0.21 )     (8,770 )     (0.02 )            
Huntington Foundation contribution
    (10,000 )     (0.03 )                        
Automobile lease residual value losses
    (5,549 )     (0.01 )                        
Severance and consolidation expenses
    (4,750 )     (0.01 )     (5,064 )     (0.01 )            
Unizan merger costs
    (3,749 )     (0.01 )                 (3,610 )     (0.01 )
Adjustment for equity method investments
    (3,240 )     (0.01 )                        
Adjustment to defer home equity annual fees
    (2,254 )     (0.01 )                        
Net impact of federal tax loss carry back(3)
                26,936       0.12              
MSR mark-to-market net of hedge-related trading activity(4)
                (7,318 )     (0.02 )     (7,174 )     (0.02 )
Single commercial credit net charge-off net of allocated reserves
                (6,464 )     (0.02 )            
Net impact of repatriating foreign earnings (3)
                (5,040 )     (0.02 )            
SEC and regulatory related expenses
                (3,715 )     (0.01 )     (13,597 )     (0.05 )
Write-off of equity investments
                (2,598 )     (0.01 )            
MSR hedging-related securities gains/(losses)
                            15,763       0.04  
Gain on sale of automobile loans
                            14,206       0.04  
Single commercial credit recovery
                            11,095       0.03  
One-time adjustment to consolidated securitization
                            3,682       0.01  
Property lease impairment
                            (7,846 )     (0.02 )
(1) See Significant Factors Influencing Financial Performance discussion.
(2) Pre-tax unless otherwise noted.
(3) After-tax.
(4) Prior to 2005, MSR valuation changes were reflected as recoveries (impairments) net of hedge-related trading activity with securities gains (losses).
Net Interest Income
(This section should be read in conjunction with Significant Factors 1 and 3.)
Our primary source of revenue is net interest income, which is the difference between interest income from earning assets, primarily loans, direct financing leases, securities, and interest expense of 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. Non-interest bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. The impact of the non-interest 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 non-interest 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 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.

20


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 4 — Change in Net Interest Income Due to Changes in Average Volume and Interest Rates(1)
                                                   
    2006   2005
 
    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
  $ 100.7     $ 246.9     $ 347.6     $ 118.6     $ 177.7     $ 296.3  
 
Securities
    30.4       46.9       77.3       (29.8 )     19.9       (9.9 )
 
Other earning assets
    (4.3 )     10.7       6.4       3.8       6.2       10.0  
 
Total interest income from earning assets
    126.8       304.5       431.3       92.6       203.8       296.4  
 
 
Deposits
    52.7       217.6       270.3       41.7       148.1       189.8  
 
Short-term borrowings
    12.6       25.3       37.9       (0.3 )     21.6       21.3  
 
Federal Home Loan Bank advances
    9.5       15.8       25.3       (4.7 )     6.1       1.4  
 
Subordinated notes and other long-term debt, including capital securities
    (21.5 )     59.9       38.4       (39.0 )     66.4       27.4  
 
Total interest expense of interest-bearing liabilities
    53.3       318.6       371.9       (2.3 )     242.2       239.9  
 
Net interest income before funding cost adjustment
    73.5       (14.1 )     59.4       94.9       (38.4 )     56.5  
Funding cost adjustment
                            (3.7 )     (3.7 )
 
Net interest income
  $ 73.5     $ (14.1 )   $ 59.4     $ 94.9     $ (42.1 )   $ 52.8  
 
(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.
2006 versus 2005
Fully taxable equivalent net interest income increased $59.4 million, or 6% ($59.0 million merger-related), from 2005, reflecting the favorable impact of a $2.1 billion, or 7%, increase in average earning assets, as the fully taxable equivalent net interest margin declined 4 basis points to 3.29%. Average total loans and leases increased $1.6 billion, or 7% ($1.4 billion merger-related). The remaining increase in average total loans and leases was $0.2 billion, up 1% from a year-ago, which primarily reflected growth in commercial loans and residential mortgages, mostly offset by a decline in total average automobile loans and leases reflecting a decline in automobile leases and little growth in automobile loans given the ongoing program of selling a portion of related loan production.
Average interest bearing deposits increased $2.0 billion from 2005, mostly related to the acquisition of Unizan. Interest expense paid on total deposits and interest bearing liabilities increased at a faster rate than earning assets throughout 2006, reducing the overall spread between interest revenue on earning assets and interest costs paid on interest bearing liabilities. Non-interest bearing deposits grew at a 4% rate, reflecting the addition of Unizan. These added balances favorably impacted the margin for 2006, offsetting lower non-deferred loan fees and the reduction in net interest margin as noted above.
2005 versus 2004
Fully taxable equivalent net interest income increased $52.8 million, or 6%, from 2004, reflecting the favorable impact of a $1.6 billion, or 6%, increase in average earning assets, as the fully taxable equivalent net interest margin remained unchanged at 3.33%.
The stability of the net interest margin reflected a combination of factors including the benefit of a shift in the earning asset mix from lower-yielding investments to higher-yielding loans as a result of decreasing the level of excess liquidity and redirecting part of the proceeds of securities sales to fund loan growth. In addition, the margin also benefited from an increase in non-interest bearing funds. These benefits were partially offset by the negative impact of intense loan and deposit price competition and share repurchases.
Average Balance Sheet
Table 5 shows average annual balance sheets and net interest margin analysis for the last 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 non-interest bearing funds represents the net interest margin.

21


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 5 — Consolidated Average Balance Sheet and Net Interest Margin Analysis
                                                                                 
    Average Balances
 
    Change from 2005       Change from 2004    
Fully taxable equivalent basis(1)                    
(in millions of dollars)   2006   Amount   %   2005   Amount   %   2004   2003   2002
 
Assets
                                                                       
Interest bearing deposits in banks
  $ 53     $       %   $ 53     $ (13 )     (19.7 )%   $ 66     $ 37     $ 33  
Trading account securities
    92       (115 )     (55.6 )     207       102       97.1       105       14       7  
Federal funds sold and securities purchased under resale agreement
    321       59       22.5       262       (57 )     (17.9 )     319       87       72  
Loans held for sale
    275       (43 )     (13.5 )     318       75       30.9       243       564       322  
 
Investment securities:
                                                                       
   
Taxable
    4,197       514       14.0       3,683       (742 )     (16.8 )     4,425       3,533       2,859  
   
Tax-exempt
    570       95       20.0       475       63       15.3       412       334       135  
 
Total investment securities
    4,767       609       14.6       4,158       (679 )     (14.0 )     4,837       3,867       2,994  
 
Loans and leases:(3)
                                                                       
   
Commercial:
                                                                       
     
Middle market commercial and industrial(4)
    5,504       687       14.3       4,817       361       8.1       4,456       4,633       4,810  
       
Construction
    1,244       (434 )     (25.9 )     1,678       258       18.2       1,420       1,219       1,151  
       
Commercial(4)
    2,703       795       41.7       1,908       (14 )     (0.7 )     1,922       1,800       1,670  
 
     
Middle market commercial real estate
    3,947       361       10.1       3,586       244       7.3       3,342       3,019       2,821  
     
Small business commercial and industrial and commercial real estate
    2,414       190       8.5       2,224       221       11.0       2,003       1,787       1,642  
 
   
Total commercial
    11,865       1,238       11.6       10,627       826       8.4       9,801       9,439       9,273  
 
   
Consumer:
                                                                       
       
Automobile loans
    2,057       14       0.7       2,043       (242 )     (10.6 )     2,285       3,260       2,744  
       
Automobile leases
    2,031       (391 )     (16.1 )     2,422       230       10.5       2,192       1,423       452  
 
     
Automobile loans and leases
    4,088       (377 )     (8.4 )     4,465       (12 )     (0.3 )     4,477       4,683       3,196  
     
Home equity
    4,970       218       4.6       4,752       508       12.0       4,244       3,400       2,976  
     
Residential mortgage
    4,581       500       12.3       4,081       869       27.1       3,212       2,076       1,438  
     
Other loans
    439       54       14.0       385       (8 )     (2.0 )     393       426       534  
 
   
Total consumer
    14,078       395       2.9       13,683       1,357       11.0       12,326       10,585       8,144  
 
 
Total loans and leases
    25,943       1,633       6.7       24,310       2,183       9.9       22,127       20,024       17,417  
 
Allowance for loan and lease losses
    (287 )     (19 )     7.1       (268 )     30       (10.1 )     (298 )     (330 )     (344 )
 
Net loans and leases
    25,656       1,614       6.7       24,042       2,213       10.1       21,829       19,694       17,073  
 
 
Total earning assets
    31,451       2,143       7.3       29,308       1,611       5.8       27,697       24,593       20,845  
 
Automobile operating lease assets
    93       (258 )     (73.5 )     351       (540 )     (60.6 )     891       1,697       2,602  
Cash and due from banks
    825       (20 )     (2.4 )     845       2       0.2       843       774       744  
Intangible assets
    567       349       N.M.       218       2       0.9       216       218       293  
All other assets
    2,463       278       12.7       2,185       101       4.8       2,084       2,020       1,923  
 
Total Assets
  $ 35,112     $ 2,473       7.6 %   $ 32,639     $ 1,206       3.8 %   $ 31,433     $ 28,972     $ 26,063  
 
Liabilities and Shareholders’ Equity
Deposits:
                                                                       
   
Demand deposits — non-interest bearing
  $ 3,530     $ 151       4.5 %   $ 3,379     $ 149       4.6 %   $ 3,230     $ 3,080     $ 2,902  
   
Demand deposits — interest bearing
    7,742       84       1.1       7,658       451       6.3       7,207       6,193       5,161  
   
Savings and other domestic time deposits
    2,992       (163 )     (5.2 )     3,155       (276 )     (8.0 )     3,431       3,462       3,583  
   
Core certificates of deposit
    5,050       1,716       51.5       3,334       645       24.0       2,689       3,115       4,175  
 
 
Total core deposits
    19,314       1,788       10.2       17,526       969       5.9       16,557       15,850       15,821  
 
Other domestic time deposits of $100,000 or more
    1,113       203       22.3       910       317       53.5       593       389       295  
 
Brokered time deposits and negotiable CDs
    3,242       123       3.9       3,119       1,282       69.8       1,837       1,419       731  
 
Deposits in foreign offices
    515       58       12.7       457       (51 )     (10.0 )     508       500       337  
 
Total deposits
    24,184       2,172       9.9       22,012       2,517       12.9       19,495       18,158       17,184  
Short-term borrowings
    1,800       421       30.5       1,379       (31 )     (2.2 )     1,410       1,600       1,856  
Federal Home Loan Bank advances
    1,369       264       23.9       1,105       (166 )     (13.1 )     1,271       1,258       279  
Subordinated notes and other long-term debt
    3,574       (490 )     (12.1 )     4,064       (1,315 )     (24.4 )     5,379       4,559       3,335  
 
 
Total interest bearing liabilities
    27,397       2,216       8.8       25,181       856       3.5       24,325       22,495       19,752  
 
All other liabilities
    1,239       (257 )     (17.2 )     1,496       (8 )     (0.5 )     1,504       1,201       1,170  
Shareholders’ equity
    2,946       363       14.1       2,583       209       8.8       2,374       2,196       2,239  
 
Total Liabilities and Shareholders’ Equity
  $ 35,112     $ 2,473       7.6 %   $ 32,639     $ 1,206       3.8 %   $ 31,433     $ 28,972     $ 26,063  
 
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)  For purposes of this analysis, non-accrual loans are reflected in the average balances of loans.
 
(4)  2005 reflects a net reclassification of $500 million from middle market commercial real estate to middle market commercial and industrial.

22


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
                                                                             
Interest Income/Expense   Average Rate(2)
 
2006   2005   2004   2003   2002   2006   2005   2004   2003   2002
 
$ 3.2     $ 1.1     $ 0.7     $ 0.6     $ 0.8       6.00 %     2.16 %     1.05 %     1.53 %     2.38 %
  3.8       8.5       4.4       0.6       0.3       4.19       4.08       4.15       4.02       4.11  
  16.1       6.0       5.5       1.6       1.1       5.00       2.27       1.73       1.80       1.56  
  16.8       17.9       13.0       30.0       20.5       6.10       5.64       5.35       5.32       6.35  
  229.4       158.7       171.7       159.6       173.0       5.47       4.31       3.88       4.52       6.05  
  38.5       31.9       28.8       23.5       10.1       6.75       6.71       6.98       7.04       7.47  
 
  267.9       190.6       200.5       183.1       183.1       5.62       4.58       4.14       4.73       6.12  
  406.0       279.0       196.5       223.5       264.5       7.38       5.79       4.41       4.82       5.50  
  100.5       107.8       64.2       51.3       52.6       8.08       6.43       4.52       4.21       4.57  
  201.7       113.2       88.0       89.4       96.2       7.46       5.93       4.58       4.97       5.76  
 
  302.2       221.0       152.2       140.7       148.8       7.65       6.16       4.55       4.66       5.27  
  173.9       137.5       110.3       105.6       110.6       7.20       6.18       5.50       5.91       6.73  
 
  882.1       637.5       459.0       469.8       523.9       7.43       6.00       4.68       5.00       5.65  
 
  135.1       133.3       165.1       242.1       237.9       6.57       6.52       7.22       7.43       8.67  
  102.9       119.6       109.6       72.8       23.2       5.07       4.94       5.00       5.12       5.14  
 
  238.0       252.9       274.7       314.9       261.1       5.82       5.66       6.14       6.73       8.17  
  369.7       288.6       208.6       166.4       166.2       7.44       6.07       4.92       4.89       5.59  
  249.1       212.9       163.0       112.2       91.4       5.44       5.22       5.07       5.40       6.35  
  39.8       39.2       29.5       36.4       50.0       9.07       10.23       7.51       8.55       9.35  
 
  896.6       793.6       675.8       629.9       568.7       6.37       5.80       5.48       5.95       6.98  
 
  1,778.7       1,431.1       1,134.8       1,099.7       1,092.6       6.86       5.89       5.13       5.50       6.27  
 
  2,086.5       1,655.2       1,358.9       1,315.6       1,298.4       6.63       5.65       4.89       5.35       6.23  
 
 
                                                         
  212.4       135.5       74.1       73.0       88.9       2.74       1.77       1.03       1.18       1.71  
  50.2       42.9       44.1       67.7       80.2       1.68       1.36       1.28       1.96       2.24  
  214.8       118.7       90.4       114.3       187.0       4.25       3.56       3.36       3.67       4.48  
 
  477.4       297.1       208.6       255.0       356.1       3.02       2.10       1.56       2.00       2.76  
  55.6       30.8       11.3       4.6       7.4       4.99       3.39       1.90       1.17       2.50  
  169.1       109.4       33.1       24.1       17.3       5.22       3.51       1.80       1.70       2.36  
  15.1       9.6       4.1       4.6       4.9       2.93       2.10       0.82       0.92       1.47  
 
  717.2       446.9       257.1       288.3       385.7       3.47       2.40       1.58       1.91       2.69  
  72.2       34.3       13.0       15.7       29.0       4.01       2.49       0.93       0.98       1.56  
  60.0       34.7       33.3       24.4       5.6       4.38       3.13       2.62       1.94       2.00  
  201.9       163.5       132.5       128.5       123.3       5.65       4.02       2.46       2.82       3.70  
 
  1,051.3       679.4       435.9       456.9       543.6       3.84       2.70       1.79       2.03       2.75  
 
 
                               
$ 1,035.2     $ 975.8     $ 923.0     $ 858.7     $ 754.8                                          
                               
                                          2.79       2.95       3.10       3.32       3.48  
                                          0.50       0.38       0.23       0.17       0.14  
 
                                          3.29 %     3.33 %     3.33 %     3.49 %     3.62 %
 

23


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Average Balance Sheet — Loans, Leases, and Other Earning Assets
2006 versus 2005
Average total commercial loans increased $1.2 billion, or 12% ($0.7 billion merger-related) from 2005. This growth reflected a $0.7 billion, or 14%, increase in average middle market commercial and industrial (C&I) loans, a $0.4 billion, or 10%, increase in average middle market commercial real estate loans (CRE), and a $0.2 billion, or 9%, increase in average small business loans.
Average residential mortgages increased $0.5 billion, or 12% ($0.3 billion merger-related). Average home equity loans increased $0.2 billion, or 5%, but would have increased less than 1% were it not for the Unizan merger.
Compared with the prior year, average total automobile loans and leases decreased $0.4 billion, or 8%, with the Unizan merger having no significant impact. The decrease reflected the combination of two factors: (1) continued softness in loan and lease production levels over this period from low consumer demand and competitive pricing and (2) little growth in automobile loans as we continued a program of selling a portion of current loan production. Average automobile operating lease assets declined $0.3 billion, or 74%, as this portfolio continued to run off. Total automobile loan and lease exposure at quarter end was 15%, down from 18% a year earlier.
Average total investment securities increased $0.6 million, or 15%, from 2005.
2005 versus 2004
Average total loans and leases increased $2.2 billion, or 10%, from 2004, primarily due to growth in consumer loans. Average total consumer loans increased $1.4 billion, or 11%, due to a $0.9 billion, or 27%, increase in average residential mortgages and a $0.5 billion, or 12%, increase in average home equity loans.
Average total automobile loans decreased $0.2 billion, or 11%, reflecting the sale of automobile loans, loan pay downs, and slowing production. Partially offsetting the decline in automobile loans was $0.2 billion, or 10%, growth in direct financing leases due to the continued migration from operating lease assets.
Average total commercial loans increased $0.8 billion, or 8%, from 2004. This reflected a $0.4 billion, or 8%, increase in middle market C&I loans, a $0.2 billion, or 7%, increase in middle market CRE loans, and a $0.2 billion, or 11%, increase in average small business C&I and CRE loans.
Average total investment securities declined $0.7 billion, or 14%, from 2004.
Average Balance Sheet — Deposits and Other Funding
2006 versus 2005
Average total core deposits in 2006 increased $1.8 billion, or 10% ($1.3 billion merger-related), from 2005. Most of the increase reflected higher average core certificates of deposit, which increased $1.7 billion ($0.5 billion merger-related) resulting from continued customer demand for higher, fixed rate deposit products. Average interest bearing demand deposits increased $0.1 billion ($0.2 billion merger-related) and average non-interest bearing deposits increased $0.2 billion ($0.1 billion merger-related). Average savings and other domestic time deposits declined $0.2 billion, despite $0.4 billion of increase related to the Unizan merger.
We use 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 2006, the average non-core funding ratio was 33%, down from 34% in 2005.
2005 versus 2004
Average total core deposits in 2005 were $17.5 billion, up $1.0 billion, or 6%, from 2004, reflecting a $0.6 billion, or 24%, increase in certificates of deposit, a $0.5 billion, or 6%, increase in average interest bearing demand deposit accounts, primarily money market accounts, and a $0.1 billion, or 5%, increase in non-interest bearing deposits. These increases were partially offset by a $0.3 billion, or 8%, decline in savings and other domestic time deposits. With interest rates rising throughout the year, demand for certificates of deposit increased as customers transferred funds from lower rate savings and other domestic time deposits into higher fixed-rate term deposit accounts.
Provision for Credit Losses
(This section should be read in conjunction with Significant Factor 3 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 our estimate of probable inherent credit losses in the loan and lease portfolio and the portfolio of unfunded loan commitments.

24


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
The provision for credit losses in 2006 was $65.2 million, down $16.1 million from a year-ago. The decrease reflected a decline in the transaction component of the allowance for loan and lease losses at year end compared with that at the end of 2005, due to a general improvement in the underlying risk of the loan portfolio, including the resolution and/or upgrades of troubled credits, a change in the composition of non-performing loans that included more residential and government-guaranteed loans, as well as a decline in the economic reserve component due to a net improvement in economic factors. These improvements were reflected in the decline in the allowance for loan and lease losses as a percent of period-end total loans and leases to 1.04% at December 31, 2006, from 1.10% a year earlier.
The provision for credit losses for 2005 was $81.3 million, up $26.2 million, or 48%, from 2004. The increase reflected loan growth as well as a higher transaction component of the allowance for loan and lease losses at the end of 2005 compared to a year earlier, due to a general deterioration in the underlying risk of the loan portfolio. These negative impacts were offset by the positive impact of a decline in the economic reserve component. The net positive impact from these factors was reflected in the decrease in the allowance for loan and lease losses as a percent of period-end total loans and leases to 1.10% at December 31, 2005, from 1.15% a year earlier.
Non-Interest Income
(This section should be read in conjunction with Significant Factors 1, 2, 3, 6, and 7.)
Non-interest income for the three years ended December 31, 2006 was as follows:
Table 6 — Non-Interest Income
                                                             
    Year Ended December 31,
 
    Change from 2005       Change from 2004    
                 
(in thousands of dollars)   2006   Amount   %   2005   Amount   %   2004
 
   
Service charges on deposit accounts
  $ 185,713     $ 17,879       10.7 %   $ 167,834     $ (3,281 )     (1.9 )%   $ 171,115  
   
Trust services
    89,955       12,550       16.2       77,405       9,995       14.8       67,410  
   
Brokerage and insurance income
    58,835       5,216       9.7       53,619       (1,180 )     (2.2 )     54,799  
   
Other service charges and fees
    51,354       7,006       15.8       44,348       2,774       6.7       41,574  
   
Bank owned life insurance income
    43,775       3,039       7.5       40,736       (1,561 )     (3.7 )     42,297  
   
Mortgage banking
    41,491       13,158       46.4       28,333       1,547       5.8       26,786  
   
Gain on sales of automobile loans
    3,095       1,884       N.M.       1,211       (12,995 )     (91.5 )     14,206  
   
Securities gains (losses)
    (73,191 )     (65,136 )     N.M.       (8,055 )     (23,818 )     N.M.       15,763  
   
Other
    116,927       23,091       24.6       93,836       (5,381 )     (5.4 )     99,217  
 
 
Sub-total before automobile operating lease income
    517,954       18,687       3.7       499,267       (33,900 )     (6.4 )     533,167  
 
Automobile operating lease income
    43,115       (89,900 )     (67.6 )     133,015       (152,416 )     (53.4 )     285,431  
 
Total non-interest income
  $ 561,069     $ (71,213 )     (11.3 )%   $ 632,282     $ (186,316 )     (22.8 )%   $ 818,598  
 
N.M., not a meaningful value.
2006 versus 2005
Non-interest income in 2006 decreased $71.2 million, or 11%, from a year-ago, including an $89.9 million decline in automobile operating lease income. That portfolio continued to run off since no automobile operating leases have been originated since April 2002. Non-interest income before automobile operating lease income increased $18.7 million, or 4% ($23.9 million merger-related), reflecting:
  –  $23.1 million increase in other income ($7.1 million merger-related), primarily reflecting $7.0 million in higher equity investment gains, a $5.7 million increase in equipment operating lease income, $3.3 million gain on sale of MasterCard® stock, and a $2.6 million increase in corporate derivative sales.
 
  –  $17.9 million, or 11% ($5.3 million merger-related), increase in service charges on deposit accounts, reflecting a $14.3 million, or 13%, increase in personal service charges, primarily NSF/ OD, and a $3.6 million, or 6%, increase in commercial service charge income.
 
  –  $13.2 million, or 46%, increase in mortgage banking income, primarily reflecting a $12.6 million positive impact between years related to MSR valuation net of hedge-related trading activity. Specifically, in 2006, MSR recoveries were $4.9 million, with $1.3 million of net trading losses associated with MSR hedging, resulting in a net positive MSR-related impact of $3.6 million. In 2005, MSR recoveries were $4.4 million, with $13.4 million of net trading losses associated with

25


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
  MSR hedging, resulting in a net reduction in mortgage-banking income in 2005 of $9.0 million. The Unizan merger had no material impact on mortgage banking income comparisons.
 
  –  $12.6 million, or 16% ($5.5 million merger-related), increase in trust services income, reflecting (1) a $6.5 million, or 18%, increase in personal trust income, mostly merger-related, (2) a $3.7 million, or 14%, increase in fees from Huntington Funds, reflecting 11% fund asset growth, and (3) a $1.8 million, or 17%, increase in institutional trust fees.
 
  –  $7.0 million, or 16% ($1.0 million merger-related), increase in other service charges and fees, primarily reflecting a $5.3 million, or 17%, increase in fees generated by higher debit card volume.
 
  –  $5.2 million, or 10% ($1.5 million merger-related), increase in brokerage and insurance income, primarily reflecting higher annuities sales related to the continued focus on investment product sales in our retail banking offices.
Partially offset by:
  –  $65.1 million increase in investment securities losses, reflecting the $73.2 million of investment securities impairment and losses during 2006 as the balance sheet restructuring was completed.
2005 versus 2004
Non-interest income decreased $186.3 million, or 23%, from 2004 with $152.4 million of the decline reflecting the decrease in operating lease income. Of the remaining $33.9 million decline from 2004, the primary drivers were:
  –  $23.8 million decline in net securities gains, as the current year reflected $8.1 million of securities losses, compared with $15.8 million of gains in 2004.
 
  –  $13.0 million decline in gains on sale of automobile loans as the year-ago period included $14.2 million of such gains.
 
  –  $5.4 million, or 5%, decline in other income reflected a combination of factors including lower income from automobile lease terminations, the $2.6 million write-off of equity investments, lower investment banking income, and lower equity investment gains.
 
  –  $3.3 million, or 2%, decline in service charges on deposit accounts, all driven by a decline in commercial service charges, reflecting a combination of lower activity and a preference by commercial customers to pay for services with higher compensating balances rather than fees as interest rates increased. Consumer service charges increased slightly.
Partially offset by:
  –  $10.0 million, or 15%, increase in trust services due to higher personal trust and mutual fund fees, reflecting a combination of higher market value of assets, as well as increased activity.
 
  –  $2.8 million, or 7%, increase in other service charges and fees, due to higher debit card fees, partially offset by lower bill pay fees as a result of a decision to eliminate fees for this service beginning in the 2004 fourth quarter.
Table 7 details mortgage banking income and the net impact of MSR hedging activity. Striking a mortgage banking income sub-total before MSR recoveries, impairments, or net trading losses or gains, provides a clearer understanding of the underlying trends in mortgage banking income associated with the primary business activities of origination, sales, and servicing.

26


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Mortgage banking income for the three years ended December 31, 2006, was as follows:
Table 7 — Mortgage Banking Income
                                                           
    Year Ended December 31,
 
    Change from 2005       Change from 2004    
                 
(in thousands of dollars)   2006   Amount   %   2005   Amount   %   2004
 
Mortgage Banking Income
                                                       
 
Origination and secondary marketing
  $ 18,217     $ (6,717 )     (26.9 )%   $ 24,934     $ 2,225       9.8 %   $ 22,709  
 
Servicing fees
    24,659       2,478       11.2       22,181       485       2.2       21,696  
 
Amortization of capitalized servicing
    (15,144 )     3,215       (17.5 )     (18,359 )     660       (3.5 )     (19,019 )
 
Other mortgage banking income
    10,173       (1,590 )     (18.5 )     8,583       (1,441 )     (14.4 )     10,024  
 
Sub-total
    37,905       566       1.5       37,339       1,929       5.4       35,410  
MSR recovery(1)
    4,871       500       11.4       4,371       2,993       N.M.       1,378  
Net trading (losses) gains related to MSR hedging
    (1,285 )     12,092       (90.4 )     (13,377 )     (3,375 )     33.7       (10,002 )
 
Total mortgage banking income
  $ 41,491     $ 13,158       46.4 %   $ 28,333     $ 1,547       5.8 %   $ 26,786  
 
Capitalized mortgage servicing rights(2)
  $ 131,104     $ 39,845       43.7 %   $ 91,259     $ 14,152       18.4 %   $ 77,107  
MSR allowance(2)
          404       N.M.       (404 )     4,371       91.5       (4,775 )
Total mortgages serviced for others (2)
    8,252,000       976,000       13.4       7,276,000       415,000       6.0       6,861,000  
                                                         
 
N.M., not a meaningful value.
(1)  In 2006, Huntington adopted Statement No. 156, under which MSRs were recorded and accounted for at fair value. Prior periods reflect temporary impairment or recovery, based on accounting for MSRs at the lower of cost or market.
 
(2)  At period end.
Non-Interest Expense
(This section should be read in conjunction with Significant Factors 1, 3, 5, and 7.)
Non-interest expense for the three years ended December 31, 2006 was as follows:
Table 8 — Non-Interest Expense
                                                               
    Year Ended December 31,
 
    Change from 2005       Change from 2004    
                 
(in thousands of dollars)   2006   Amount   %   2005   Amount   %   2004
 
     
Salaries
  $ 425,657     $ 46,068       12.1 %   $ 379,589     $ 3,321       0.9 %   $ 376,268  
     
Benefits
    115,571       13,502       13.2       102,069       (7,469 )     (6.8 )     109,538  
 
   
Personnel costs
    541,228       59,570       12.4       481,658       (4,148 )     (0.9 )     485,806  
 
   
Outside data processing and other services
    78,779       4,141       5.5       74,638       2,523       3.5       72,115  
   
Net occupancy
    71,281       189       0.3       71,092       (4,849 )     (6.4 )     75,941  
   
Equipment
    69,912       6,788       10.8       63,124       (218 )     (0.3 )     63,342  
   
Marketing
    31,728       5,449       20.7       26,279       1,679       6.8       24,600  
   
Professional services
    27,053       (7,516 )     (21.7 )     34,569       (2,307 )     (6.3 )     36,876  
   
Telecommunications
    19,252       604       3.2       18,648       (1,139 )     (5.8 )     19,787  
   
Printing and supplies
    13,864       1,291       10.3       12,573       110       0.9       12,463  
   
Amortization of intangibles
    9,962       9,133       N.M.       829       12       1.5       817  
   
Restructuring reserve releases
                            1,151       N.M.       (1,151 )
   
Other
    106,649       24,089       29.2       82,560       (14,008 )     (14.5 )     96,568  
 
 
Sub-total before automobile operating lease expense
    969,708       103,738       12.0       865,970       (21,194 )     (2.4 )     887,164  
Automobile operating lease expense
    31,286       (72,564 )     (69.9 )     103,850       (131,230 )     (55.8 )     235,080  
 
Total non-interest expense
  $ 1,000,994     $ 31,174       3.2 %   $ 969,820     $ (152,424 )     (13.6 )%   $ 1,122,244  
 
N.M., not a meaningful value.
2006 versus 2005
Non-interest expense in 2006 increased $31.2 million, or 3%, from 2005, despite a $72.6 million decline in automobile operating lease expense as that portfolio continued to run off. Non-interest expense before automobile operating lease expense increased $103.7 million, or 12% ($59.7 million merger-related), reflecting:

27


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
  –  $59.6 million, or 12%, increase in personnel expense, with Unizan contributing $25.8 million, or 43%, of the increase. The remaining $33.8 million increase included $17.0 million increase in share-based compensation primarily related to the expensing of stock options, which began in 2006, and $9.0 million in higher performance and sales-related compensation.
 
  –  $24.1 million, or 29% ($10.0 million merger-related), increase in other expense, including a $10.0 million donation to the Huntington Foundation in the fourth quarter, which will result in reduced contributions in future periods, $5.5 million of higher residual value losses on automobile leases, $3.7 million of Unizan merger-related costs, and $3.5 million related to the fourth quarter restructuring of certain FHLB advances.
 
  –  $9.1 million increase in the amortization of intangibles, substantially all merger-related.
 
  –  $6.8 million, or 11%, increase in equipment expense ($1.7 million merger-related), reflecting higher depreciation associated with recent technology investments.
 
  –  $5.4 million, or 21% ($0.9 million merger-related), increase in marketing expense, reflecting increased campaign and market research expenses.
 
  –  $4.1 million, or 6%, increase in outside data processing and other services ($1.7 million merger-related), with $2.0 million related to Unizan system conversion merger-related costs and a $1.7 million increase in debit card processing costs due to higher activity levels.
Partially offset by:
  –  $7.5 million, or 22%, decline in professional services expenses, despite Unizan adding $4.9 million, including a reduction in SEC/regulatory related expenses, as well as declines in collections and other consulting expenses.
2005 versus 2004
Non-interest expense decreased $152.4 million, or 14%, from 2004 with $131.2 million of the decline reflecting the decrease in operating lease expense. Of the remaining $21.2 million decline, the primary drivers were:
  –  $14.0 million, or 15%, decrease in other expense, reflecting decreased SEC and regulatory-related expenses in 2005, $5.8 million of costs related to investments in partnerships generating tax benefits in the year-ago period, and lower litigation related expense accruals and lower insurance costs in 2005.
 
  –  $4.8 million, or 6%, decline in net occupancy expense, as 2004 included a $7.8 million loss caused by property lease impairments, partially offset by lower rental income and higher depreciation expense in 2005.
 
  –  $4.1 million, or 1%, decline in personnel costs, mainly due to lower commission and benefit expense, partially offset by higher salaries and severance.
SEC-related expenses and accruals, as well as expenses related to Unizan integration planning and systems conversions, contributed to the change in expense from 2005. Specifically, SEC/regulatory-related expenses and accruals while not meaningful in 2006, totaled $3.7 million in 2005, and $13.6 million in 2004. These expenses and accruals impacted the professional services and other expense categories. Unizan merger-related costs, primarily related to integration planning and systems conversion expenses, totaled $3.7 million in 2006, $0.7 million in 2005, and $3.6 million in 2004. 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.
Operating Lease Assets
(This section should be read in conjunction with the Significant Factor 3.)
Operating lease assets represent automobile leases originated before May 2002. This operating lease portfolio is running 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

28


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
with the operating lease portfolio have declined. Operating lease assets performance for the five years ended December 31, 2006 was as follows:
Table 9 — Automobile Operating Lease Performance
                                           
    Year Ended December 31,
 
(in thousands of dollars)   2006   2005   2004   2003   2002
 
Balance Sheet:
                                       
Average automobile operating lease assets outstanding
  $ 92,613     $ 351,213     $ 890,930     $ 1,696,535     $ 2,602,154  
 
Income Statement:
                                       
 
Net rental income
  $ 37,512     $ 121,101     $ 265,542     $ 458,644     $ 615,453  
 
Fees
    2,021       6,531       13,457       21,623       28,542  
 
Recoveries — early termination losses
    3,582       5,383       6,432       9,431       13,079  
 
Total automobile operating lease income
    43,115       133,015       285,431       489,698       657,074  
 
 
Depreciation and residual losses at termination
    28,591       94,816       215,047       350,550       463,783  
 
Losses — early terminations
    2,695       9,034       20,033       42,720       55,187  
 
Total automobile operating lease expense
    31,286       103,850       235,080       393,270       518,970  
 
Net earnings contribution
  $ 11,829     $ 29,165     $ 50,351     $ 96,428     $ 138,104  
 
2006 versus 2005
The net earnings contribution from automobile operating leases was $11.8 million in 2006, down 60% from $29.2 million in 2005. Operating lease income, which totaled $43.1 million in 2006, and represented 8% of non-interest income, declined 68% from 2005, reflecting the decline in average operating leases. The majority of this decline was reflected in lower net rental income, down 69% from 2005. Lower fees and recoveries from early termination losses also contributed to the decline in total automobile operating lease income, but to a much lesser degree. Automobile operating lease expense totaled $31.3 million for 2006, down 70% from a year ago, also reflecting the continued decline in operating lease assets, with the decline related to lower depreciation and residual losses at termination.
2005 versus 2004
The net earnings contribution from automobile operating leases in 2005 was $29.2 million in 2005, down 42% from $50.4 million in 2004. Automobile operating lease income, which totaled $133.0 million in 2005, and represented 21% of non-interest income, declined 53% from 2004, reflecting the decline in average operating leases. The majority of this decline was reflected in lower net rental income, as well as lower fees and recoveries from early termination losses. Automobile operating lease expense totaled $103.9 million for 2005, down 56% from a year ago, also reflecting the continued decline in operating lease assets, with the decline related to lower depreciation and residual losses at termination expenses.
Provision for Income Taxes
(This section should be read in conjunction with Significant Factor 4.)
The provision for income taxes was $52.8 million in 2006, $131.5 million in 2005, and $153.7 million in 2004. The effective tax rate was 10.3%, 24.2%, and 27.8% in 2006, 2005, and 2004 respectively. The lower effective tax rate in 2006 reflected a release of previously established federal income tax reserves due to the resolution of a federal income tax audit covering tax years 2002 and 2003, as well as the recognition of a federal tax loss carryback. The lower effective tax rate in 2005 compared with 2004 reflected an increasing benefit from tax-exempt income and a federal tax loss carryback, partially offset by the effect of the repatriation of foreign earnings. (See Note 20 of the Notes to Consolidated Financial Statements.)
During 2006, the Internal Revenue Service concluded its audit of our consolidated federal income tax returns for tax years 2002 and 2003. Also, the Internal Revenue Service concluded its examination of the 2003 income tax returns for Unizan. Tax reserves and related interest accruals were adjusted to reflect the resolution of these audits. In addition, we are subject to ongoing tax examinations in various jurisdictions. We believe that the resolution of these examinations will not have a significant, adverse impact on our consolidated financial position or results of operations.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
RISK MANAGEMENT AND CAPITAL
Risk identification and monitoring are key elements in overall risk management. We believe our primary risk exposures are credit, market, liquidity, and operational 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, 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. Operational risk arises from the inherent day-to-day operations of the company that could result in losses due to human error, inadequate or failed internal systems and controls, and external events.
We follow a formal policy to identify, measure, and document the key risks facing the company, how those risks can be controlled or mitigated, and how we monitor the controls to ensure that they are effective. Our chief risk officer is responsible for ensuring that appropriate systems of controls are in place for managing and monitoring risk across the company. Potential risk concerns are shared with the board of directors, as appropriate. Our 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.
Some of the more significant processes used to manage and control credit, market, liquidity, and operational 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. We are 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 our 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.
The maximum level of credit exposure to individual commercial borrowers is limited by policy guidelines based on the risk of default 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 via limits on loan type, geography, industry, loan quality factors, and country limits. We have focused on extending credit to commercial customers with existing or expandable relationships within our primary banking markets.
The checks and balances in the credit process and the independence of the credit administration and risk management functions are designed to assess the level of credit risk being accepted, facilitate the early recognition of credit problems when they do occur, and to provide for effective problem asset management and resolution.
Credit Exposure Mix
(This section should be read in conjunction with Significant Factors 1 and 3.)
An overall corporate objective is to avoid undue portfolio concentrations. As shown in Table 10, at December 31, 2006, total credit exposure was $26.2 billion. Of this amount, $13.8 billion, or 53%, represented total consumer loans and leases, and $12.4 billion, or 47%, total commercial loans and leases.
A specific portfolio concentration objective has been to reduce the relative level of total automobile exposure (the sum of automobile loans, automobile leases, securitized and operating lease assets) from its 33% level at the end of 2002. As shown in Table 10, such exposure was 15% at December 31, 2006.
In contrast, another specific portfolio concentration objective has been to increase the relative level of lower-risk residential mortgages and home equity loans. At December 31, 2006, such loans represented 36% of total credit exposure, up from 22% at the end of 2002.
From 2002 through 2005, the level of total commercial loans and leases has remained relatively constant at 42%-44% of total credit exposure. However, at the end of 2006, the level had increased to 47%, reflecting growth in commercial loans, as well as lower relative levels of consumer automobile leases. Middle market C&I loans declined to 19% at year-end 2004 from 22% at

30


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
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 on commercial lending to customers with existing or potential relationships within our primary markets. Since then, that concentration increased to 23%, reflecting increased customer demand.
Table 10 — Loan and Lease Portfolio Composition
                                                                                       
    At December 31,
 
(in millions of dollars)   2006   2005   2004   2003   2002
 
 
Commercial(1)
                                                                               
   
Middle market commercial and industrial
  $ 5,953       22.7 %   $ 5,084       20.6 %   $ 4,666       19.3 %   $ 4,416       19.7 %   $ 4,757       21.7 %
     
Construction
    987       3.8       1,522       6.2       1,602       6.6       1,264       5.6       983       4.5  
     
Commercial
    2,874       11.0       2,015       8.2       1,917       7.9       1,919       8.6       1,896       8.7  
 
   
Total middle market real estate
    3,861       14.8       3,537       14.4       3,519       14.5       3,183       14.2       2,879       13.2  
   
Small business commercial and industrial and commercial real estate
    2,540       9.6       2,224       9.1       2,118       8.8       1,887       8.4       1,695       7.7  
 
 
Total commercial
    12,354       47.1       10,845       44.1       10,303       42.6       9,486       42.3       9,331       42.6  
 
  Consumer:                                                                                
    Automobile loans     2,126       8.1       1,985       8.1       1,949       8.1       2,992       13.4       3,042       13.9  
    Automobile leases     1,769       6.8       2,289       9.3       2,443       10.1       1,902       8.5       874       4.0  
    Home equity     4,927       18.8       4,763       19.3       4,647       19.2       3,746       16.7       3,142       14.3  
    Residential mortgage     4,549       17.4       4,193       17.0       3,829       15.9       2,531       11.3       1,746       8.0  
    Other loans     428       1.7       397       1.4       389       1.7       418       2.0       452       2.1  
 
 
Total consumer
    13,799       52.8       13,627       55.1       13,257       55.0       11,589       51.9       9,256       42.3  
 
Total loans and direct financing leases
    26,153       99.9       24,472       99.2       23,560       97.6       21,075       94.2       18,587       84.9  
 
Operating lease assets
    28       0.1       189       0.8       587       2.4       1,260       5.6       2,201       10.0  
Securitized loans
                                        37       0.2       1,119       5.1  
 
Total credit exposure
  $ 26,181       100.0 %   $ 24,661       100.0 %   $ 24,147       100.0 %   $ 22,372       100.0 %   $ 21,907       100.0 %
 
Total automobile exposure(2)
  $ 3,923       15.0 %   $ 4,463       18.1 %   $ 4,979       20.6 %   $ 6,191       27.7 %   $ 7,236       33.0 %
 
(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 automobile loans and leases, operating lease assets, and securitized loans.
Table 11 — Commercial & Industrial and CRE Loan and Lease Detail
                                               
    At December 31,
 
(in millions of dollars)   2006   2005   2004   2003   2002
 
     
Commercial and industrial loans
  $ 4,735     $ 3,998     $ 3,632     $ 3,463     $ 4,031  
     
Dealer floor plan loans
    631       615       645       635       534  
     
Equipment direct financing leases
    587       471       389       318       192  
 
   
Middle market commercial and industrial loans and leases
    5,953       5,084       4,666       4,416       4,757  
   
Small business commercial and industrial loans
    1,897       1,725       1,164       898       851  
 
 
Commercial and industrial loans and leases
    7,850       6,809       5,830       5,314       5,608  
 
   
Middle market commercial real estate loans
    3,861       3,537       3,519       3,183       2,879  
   
Small business commercial real estate loans
    643       499       954       989       844  
 
Commercial real estate loans
    4,504       4,036       4,473       4,172       3,723  
 
Total commercial loans and leases
  $ 12,354     $ 10,845     $ 10,303     $ 9,486     $ 9,331  
 
Commercial Credit
Commercial credit approvals are based on the financial strength of the borrower, assessment of the borrower’s management capabilities, industry sector trends, and type of exposure, transaction structure, and the general economic outlook. While these are the primary factors considered, there are a number of other factors that may be considered in the decision process. 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. Even in this centralized decision environment, individual credit authority is granted to certain individuals on a regional basis to preserve our local decision-making focus. The second, and more prevalent

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
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 and lease commitments and balances outstanding by industry classification code at December 31, 2006 were as follows:
Table 12 — Commercial and Industrial Loans and Leases by Industry Classification Code
                                   
    At December 31, 2006
 
    Commitments   Loans Outstanding
         
(in thousands of dollars)   Amount   %   Amount   %
 
Industry Classification:
                               
 
Services
  $ 3,359,799       26.2 %   $ 2,135,915       27.2 %
 
Manufacturing
    2,357,190       18.4       1,419,198       18.1  
 
Retail trade
    2,175,921       16.9       1,326,383       16.9  
 
Finance, insurance, and real estate
    2,037,878       15.9       1,223,630       15.6  
 
Contractors and construction
    980,529       7.6       618,794       7.9  
 
Wholesale trade
    747,790       5.8       346,854       4.4  
 
Transportation, communications, and utilities
    662,972       5.2       406,902       5.2  
 
Agriculture and forestry
    302,847       2.4       206,039       2.6  
 
Energy
    158,988       1.2       119,286       1.5  
 
Public administration
    45,030       0.4       38,364       0.5  
 
Other
    14,475             8,547       0.1  
 
Total
  $ 12,843,419       100.0 %   $ 7,849,912       100.0 %
 
Middle market CRE loans and small business CRE loans totaled $4.5 billion at December 31, 2006. These loans were predominantly for properties located in our primary banking markets, and were diversified by the type of property, as reflected in the following table:
Table 13 — Commercial Real Estate Loans by Property Type and Borrower Location
                                                           
    At December 31, 2006
 
    Geographic Region    
         
        West       Total   Percent of
(in thousands of dollars)   Ohio   Michigan   Virginia   Indiana   Other   Amount   Total
 
 
Retail properties
  $ 413,850     $ 181,180     $ 29,101     $ 71,873     $     $ 696,004       15.5 %
 
Office
    333,798       169,781       49,751       17,028       1,644       572,002       12.7  
 
Unsecured lines to real estate companies
    377,375       80,249       11,602       23,372       2,106       494,704       11.0  
 
Industrial and warehouse
    234,783       182,105       13,278       39,318       2,372       471,856       10.5  
 
Multi family
    306,186       58,764       26,070       68,845       3       459,868       10.2  
 
Single family development
    279,756       119,529       18,729       9,881             427,895       9.5  
 
Raw land
    194,262       128,387       23,965       49,005       5,604       401,223       8.9  
 
Condominium construction
    124,679       53,828       4,844       1,043             184,394       4.1  
 
Other land uses
    119,470       41,788       10,780       11,418             183,456       4.1  
 
Hotel
    104,767       60,718       4,523       5,154             175,162       3.9  
 
Single family land development
    113,322       15,126       504       4,988       6,144       140,084       3.1  
 
Recreational
    88,183       18,839       6,995       1,882             115,899       2.6  
 
Health care
    57,213       28,136       11,114       1,821             98,284       2.2  
 
Other land development
    63,686       12,809       1,700       5,514             83,709       1.9  
 
Total
  $ 2,811,330     $ 1,151,239     $ 212,956     $ 311,142     $ 17,873     $ 4,504,540       100.0 %
 
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 results in 192 individual loan grades, provides granularity in the portfolio management process. The probability-of-default is rated on a scale of 1-12 and is applied at the borrower level. The

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
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. Analysis of actual default experience indicated that the assigned probability of default was higher than our actual experience. Accordingly, during the 2006 third quarter, we updated the criteria used to assess the probability-of-default on commercial and industrial credits. The application of these updated criteria had no significant impact on the allowance for credit losses. We continually review and adjust such criteria based on actual experience, which may result in further changes to such criteria, in future periods.
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, and the loan review group validates the risk grades on a minimum of 50% of the portfolio exposure.
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 lower. 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, and the transaction structure. 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 our 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 most recent credit bureau score (FICO), 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. We make 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.
Home equity loans and lines consist of both first and second position collateral with underwriting criteria based on minimum FICO credit scores, debt-to-income ratios, and loan-to-value ratios. We offer closed-end home equity loans with a fixed interest rate and level monthly payments and a variable-rate, interest-only home equity line of credit. At December 31, 2006, we had $1.7 billion of home equity loans and $3.2 billion of home equity lines of credit. The average loan-to-value ratio of our home equity portfolio (both loans and lines) was 77% at December 31, 2006. We do not originate home equity loans or lines that allow negative amortization, or have a loan-to-value ratio at origination greater than 100%. Home equity loans are generally fixed rate with periodic principal and interest payments. We originated $619 million of home equity loans in 2006 with a weighted average loan-to-value ratio of 64% and a weighted average FICO score of 734. Home equity lines of credit generally have variable rates of interest and do not require payment of principal during the 10-year revolving period of the line. During 2006, we originated commitments of $1.3 billion of home equity lines. The lines of credit originated during the year had a weighted average loan-to-value ratio of 75% and a weighted average FICO score of 741.
At December 31, 2006, we had $4.5 billion of residential real estate loans. Adjustable-rate mortgages (ARMs), primarily mortgages that have a fixed-rate for the first 3 to 5 years and then adjust annually, comprised 54% of this portfolio. We do not originate residential mortgage loans that (a) allow negative amortization, (b) have a loan-to-value ratio at origination greater than 100%, or (c) are “option ARMs.” Interest-only loans comprised $0.8 billion, or 18%, of residential real estate loans at December 31,

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
2006. Interest only loans are underwritten to specific standards including minimum FICO credit scores, stressed debt-to-income ratios, and extensive collateral evaluation.
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 consumer loans and leases. (See the Non-performing Assets section of Credit Risk, for further information regarding when consumer loans are placed on non-accrual status and when the balances are charged-off to the allowance for loan and lease losses.)
Non-Performing Assets (NPAs)
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. Middle-market commercial and industrial (C&I), middle market commercial real-estate (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 and home equity lines and leases, 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 and home equity loans and lines, while highly secured, are placed on non-accrual status within 180-days past due as to principal or 210-days past due as to interest, regardless of collateral. 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 other real estate owned (OREO).
When we believe 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.
Non-performing loans (NPLs) increased during 2006 across most of our product lines. A significant portion of the increase ($33.8 million) was a result of the inclusion of the Unizan portfolio in 2006. It is important to note that the Unizan portfolio included $12 million of NPLs guaranteed by the Small Business Administration. We anticipate that the government guarantees will result in full repayment of principal and interest of the related loans. We have seen an increase in NPLs in the residential real estate portfolio as a result of the general economy and the housing environment in our markets.
The 2006 increase in OREO was entirely a function of the residential loan portfolio, and includes a $16.2 million impact for an accounting reclassification, from residential mortgage loans, associated with assets insured by the Department of Housing and Urban Development (HUD). HUD insures 100% of the unpaid principal balance of the loan and reimburses the lender for interest and expenses in accordance with HUD regulations. In previous periods, these 100% government insured loans were not considered OREO assets. All OREO assets are written down to a net realizable value at transfer to OREO.
While the level of our NPAs was higher at the end of 2006 than a year earlier, the absolute dollar amount of future risk associated with NPAs was not materially different as a result of the improved asset mix and greater relative amount of government guaranteed assets. Of the 2006 increase, 83% consisted of residential real estate and government guaranteed loans.
Non-performing asset activity for the past five years was as follows:

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 14 — Non-Performing Assets and Past Due Loans and Leases
                                             
    At December 31,
 
(in thousands of dollars)   2006   2005   2004   2003   2002
 
Non-performing loans and leases(1):
                                       
   
Middle market commercial and industrial
  $ 35,657     $ 28,888     $ 24,179     $ 33,745     $ 79,691  
   
Middle market commercial real estate
    34,831       15,763       4,582       18,434       19,875  
   
Small business commercial and industrial and commercial real estate
    25,852       28,931       14,601       13,607       19,060  
   
Residential mortgage
    32,527       17,613       13,545       9,695       9,443  
   
Home equity
    15,266       10,720       7,055              
 
Total non-performing loans and leases
    144,133       101,915       63,962       75,481       128,069  
Other real estate, net:
                                       
 
Residential(2)
    47,898       14,214       8,762       6,918       7,915  
 
Commercial(3)
    1,589       1,026       35,844       4,987       739  
 
Total other real estate, net
    49,487       15,240       44,606       11,905       8,654  
 
Total non-performing assets
  $ 193,620     $ 117,155     $ 108,568     $ 87,386     $ 136,723  
 
Non-performing loans and leases as a % of total loans and leases
    0.55 %     0.42 %     0.27 %     0.36 %     0.69 %
Non-performing assets as a % of total loans and leases and other real estate
    0.74       0.48       0.46       0.41       0.74  
Accruing loans and leases past due 90 days or more(2)
  $ 59,114     $ 56,138     $ 54,283     $ 55,913     $ 61,526  
Accruing loans and leases past due 90 days or more as a percent of total loans
and leases
    0.23 %     0.23 %     0.23 %     0.27 %     0.33 %
Total allowances for credit losses (ACL) as % of:
                                       
 
Total loans and leases
    1.19       1.25       1.29       1.59       1.81  
 
Non-performing loans and leases
    217       300       476       444       263  
 
Non-performing assets
    161       261       280       384       246  
(1)  Non-performing loans and leases include loans and leases on non-accrual status and restructured loans and leases. For all periods presented, there were no restructured loans and leases that were not also on non-accrual status.
 
(2)  Beginning in 2006, OREO includes balances of loans in foreclosure, which are fully guaranteed by the U.S. Government, that were reported in 90 day past due loans and leases in prior periods.
 
(3)  At December 31, 2004, other real estate owned included $35.7 million of properties that related to the workout of $5.9 million of mezzanine loans. These properties were subject to $29.8 million of non-recourse debt to another financial institution. These properties were sold in 2005.
Table 15 — Non-Performing Asset Activity
                                           
    Year Ended December 31,
 
(in thousands of dollars)   2006   2005   2004   2003   2002
 
Non-performing assets, beginning of year
  $ 117,155     $ 108,568     $ 87,386     $ 136,723     $ 227,493  
 
New non-performing assets(1),(2)
    222,043       171,150       137,359       222,043       260,229  
 
Acquired non-performing assets
    33,843                          
 
Returns to accruing status
    (43,999 )     (7,547 )     (3,795 )     (16,632 )     (17,124 )
 
Loan and lease losses
    (46,191 )     (38,819 )     (37,337 )     (109,905 )     (152,616 )
 
Payments
    (59,469 )     (64,861 )     (43,319 )     (83,886 )     (136,774 )
 
Sales(1)
    (29,762 )     (51,336 )     (31,726 )     (60,957 )     (44,485 )
 
Non-performing assets, end of year
  $ 193,620     $ 117,155     $ 108,568     $ 87,386     $ 136,723  
 
(1)  In 2004, new non-performing assets included $35.7 million of properties that relate to the workout of $5.9 million of mezzanine loans. These properties were subject to $29.8 million of non-recourse debt to another financial institution. These properties were sold in 2005.
 
(2)  Beginning in 2006, OREO includes balances of loans in foreclosure, which are fully guaranteed by the U.S. Government, that were reported in 90 day past due loans and leases in prior periods.
Allowances for Credit Losses
(This section should be read in conjunction with Significant Factors 1 and 3.)
We maintain 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 ACL. Our credit administration group is responsible for developing the methodology and determining the adequacy of the ACL.
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 or recoveries, while reductions reflect charge-offs, net of recoveries,

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
or the sale of loans. The AULC is determined by applying the transaction reserve process to the unfunded portion of the portfolio adjusted by an applicable funding percentage.
We have an established process to determine the adequacy of the ACL that relies on a number of analytical tools and benchmarks. No single statistic or measurement, in itself, determines the adequacy of the allowance. The allowance is comprised of two components: the transaction reserve and the economic reserve.
The transaction reserve component of the ACL includes both (a) an estimate of loss based on pools of commercial and consumer loans and leases with similar characteristics and (b) an estimate of loss based on an impairment review of each loan greater than $500,000 that is considered to be impaired. For commercial loans, the estimate of loss based on pools of loans and leases with similar characteristics is made through 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 our own portfolio and external industry data. In the case of more homogeneous portfolios, such as consumer loans and leases, the determination of the transaction reserve is based on reserve factors that include the use of forecasting models to measure inherent loss in these portfolios. We update the models and analyses 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.
The economic reserve incorporates our 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 economic indices as well as a variety of other economic factors that are correlated to the historical performance of the loan portfolio. Currently, two national and two regionally focused indices are utilized. The two national indices are: (1) the Real Consumer Spending, and (2) Consumer Confidence. The two regionally focused indices are: (1) the Institute for Supply Management Manufacturing, and (2) Non-agriculture Job Creation. Because of this more quantitative approach to recognizing risks in the general economy, the economic reserve may fluctuate from period-to-period, subject to a minimum level specified by policy.
This methodology allows for a more meaningful discussion of our view of the current economic conditions and the potential impact on credit losses. The continued use of quantitative methodologies for the transaction reserve and the introduction of the quantitative methodology for the economic component may have the impact of more period-to-period fluctuation in the absolute and relative level of the reserve than exhibited in prior-period results.
The table below presents the components of the ACL expressed as a percent of total period end loans and leases at the end of the most recent five years:
Table 16 — ACL as a Percent of Total Period End Loans and Leases
                                           
    At December 31,
 
    2006   2005   2004   2003   2002
 
 
Transaction reserve
    0.86 %     0.89 %     0.83 %     N.A.       N.A.  
 
Economic reserve
    0.18       0.21       0.32       N.A.       N.A.  
 
Total ALLL
    1.04       1.10       1.15       1.42 %     1.62 %
Total AULC
    0.15       0.15       0.14       0.17       0.19  
 
Total ACL
    1.19 %     1.25 %     1.29 %     1.59 %     1.81 %
 
N.A., not applicable.
A change in the transaction reserve component of the ACL is a direct indicator of the direction of credit risk in the portfolio. The decline in 2006 from 0.89% to 0.86% is consistent with our general assessment that there is less inherent credit risk in the portfolio today than in the prior period. The economic reserve is a calculated multiplier to the transaction reserve to capture potential volatility associated with the economic environment. The general improvement in the economy, combined with Huntington’s very consistent loss levels result in the lowering of the economic reserve component.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 17 — Allocation of Allowances for Credit Losses(1)
                                                                                   
    At December 31,
 
(in thousands of dollars)   2006   2005   2004   2003   2002
 
Commercial:
                                                                               
 
Middle market commercial and industrial
  $ 83,046       22.9 %   $ 82,963       20.8 %   $ 87,485       19.8 %   $ 103,237       21.0 %   $ 106,998       25.6 %
 
Middle market commercial real estate
    63,729       14.7       60,667       14.4       54,927       14.9       63,294       15.1       35,658       15.5  
 
Small business commercial and industrial and commercial real estate
    42,978       9.7       40,056       9.1       32,009       9.0       30,455       8.9       26,914       9.1  
 
Total commercial
    189,753       47.3       183,686       44.3       174,421       43.7       196,986       45.0       169,570       50.2  
 
Consumer:
                                                                               
 
Automobile loans and leases
    28,400       14.9       33,870       17.5       41,273       18.6       58,375       23.2       51,621       21.1  
 
Home equity
    32,572       18.8       30,245       19.5       29,275       19.3       25,995       17.7       16,878       16.9  
 
Residential mortgage
    13,349       17.4       13,172       17.1       18,995       16.3       11,124       12.0       8,566       9.4  
 
Other loans
    7,994       1.6       7,374       1.6       7,247       2.1       7,252       2.1       8,085       2.4  
 
Total consumer
    82,315       52.7       84,661       55.7       96,790       56.3       102,746       55.0       85,150       49.8  
 
Total unallocated(2)
                                                      45,783        
 
Total allowance for loan and lease losses
  $ 272,068       100.0 %   $ 268,347       100.0 %   $ 271,211       100.0 %   $ 299,732       100.0 %   $ 300,503       100.0 %
 
Allowance for unfunded loan commitments and letters of credit
    40,161               36,957               33,187               35,522               36,145          
 
Total allowances for credit losses
  $ 312,229             $ 305,304             $ 304,398             $ 335,254             $ 336,648          
 
(1)  Percentages represent the percentage of each loan and lease category to total loans and leases.
 
(2)  Prior to 2003, an unallocated component of the ALLL was maintained.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 18 — Summary of Allowances for Credit Losses and Related Statistics
                                               
    Year Ended December 31,
 
(in thousands of dollars)   2006   2005   2004   2003   2002
 
Allowance for loan and lease losses, beginning of year
  $ 268,347     $ 271,211     $ 299,732     $ 300,503     $ 345,402  
Acquired allowance for loan and lease losses
    23,785                          
Loan and lease charge-offs                                        
 
Commercial:
                                       
   
Middle market commercial and industrial
    (14,706 )     (22,247 )     (21,095 )     (86,217 )     (112,430 )
     
Construction
    (4,156 )     (534 )     (2,477 )     (3,092 )     (4,343 )
     
Commercial
    (3,009 )     (4,311 )     (5,650 )     (6,763 )     (13,383 )
 
   
Middle market commercial real estate
    (7,165 )     (4,845 )     (8,127 )     (9,855 )     (17,726 )
   
Small business commercial and industrial and commercial real estate
    (19,922 )     (16,707 )     (10,270 )     (16,311 )     (18,587 )
 
 
Total commercial
    (41,793 )     (43,799 )     (39,492 )     (112,383 )     (148,743 )
 
 
Consumer:
                                       
     
Automobile loans
    (20,262 )     (25,780 )     (45,335 )     (57,890 )     (57,675 )
     
Automobile leases
    (13,527 )     (12,966 )     (11,690 )     (5,632 )     (1,335 )
 
   
Automobile loans and leases
    (33,789 )     (38,746 )     (57,025 )     (63,522 )     (59,010 )
   
Home equity
    (24,950 )     (20,129 )     (17,514 )     (14,166 )     (13,395 )
   
Residential mortgage
    (4,767 )     (2,561 )     (1,975 )     (915 )     (888 )
   
Other loans
    (14,393 )     (10,613 )     (10,109 )     (10,548 )     (12,316 )
 
 
Total consumer
    (77,899 )     (72,049 )     (86,623 )     (89,151 )     (85,609 )
 
Total charge-offs
    (119,692 )     (115,848 )     (126,115 )     (201,534 )     (234,352 )
 
 
Recoveries of loan and lease charge-offs
Commercial:
                                       
   
Middle market commercial and industrial
    8,389       8,669       19,175       10,414       7,727  
     
Construction
    602       399       12       164       127  
     
Commercial
    454       401       144       1,744       1,415  
 
   
Middle market commercial real estate
    1,056       800       156       1,908       1,542  
   
Small business commercial and industrial and commercial real estate
    4,696       4,756       4,704       4,686       4,071  
 
  Total commercial     14,141       14,225       24,035       17,008       13,340  
 
 
Consumer:
                                       
     
Automobile loans
    11,975       13,792       16,761       17,603       18,559  
     
Automobile leases
    3,040       1,302       853       (75 )     (95 )
 
   
Automobile loans and leases
    15,015       15,094       17,614       17,528       18,464  
   
Home equity
    3,096       2,510       2,440       2,052       1,555  
   
Residential mortgage
    262       229       215       83       16  
   
Other loans
    4,802       3,733       3,276       3,054       4,065  
 
 
Total consumer
    23,175       21,566       23,545       22,717       24,100  
 
Total recoveries
    37,316       35,791       47,580       39,725       37,440  
 
Net loan and lease charge-offs
    (82,376 )     (80,057 )     (78,535 )     (161,809 )     (196,912 )
 
Provision for loan and lease losses
    62,312       83,782       57,397       164,616       182,211  
Economic reserve transfer
          (6,253 )                  
Allowance for assets sold and securitized
          (336 )     (7,383 )     (3,578 )     (30,198 )
 
Allowance for loan and lease losses, end of year
  $ 272,068     $ 268,347     $ 271,211     $ 299,732     $ 300,503  
 
 
Allowance for unfunded loan commitments and letters of credit, beginning of year
  $ 36,957     $ 33,187     $ 35,522     $ 36,145     $ 23,930  
Acquired AULC
    325                          
Provision for unfunded loan commitments and letters of credit losses
    2,879       (2,483 )     (2,335 )     (623 )     12,215  
Economic reserve transfer
          6,253                    
 
Allowance for unfunded loan commitments and letters of credit, end of year
    40,161       36,957       33,187       35,522       36,145  
 
Allowance for credit losses, end of year
  $ 312,229     $ 305,304     $ 304,398     $ 335,254     $ 336,648  
 
 
Net loan and lease losses as a % of average total loans and leases
    0.32 %     0.33 %     0.35 %     0.81 %     1.13 %
Allowance for credit losses as a % of total period end loans and leases
    1.19       1.25       1.29       1.59       1.81  

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Net Charge-offs
While there has been variability at the business line level in losses over the past three years, our overall performance has been very consistent with our expectations. Results in 2006 were very consistent with 2005 results in the commercial portfolios and automobile loans and leases. Net charge-offs increased in the residential secured portion of the portfolio. These results are consistent with expectations, as we continue to operate at or below our expected long-term targets for each portfolio. There is likely to be variation on a quarterly basis, but we continue to expect our overall charge-offs to remain at the low end of our total portfolio range as shown in table 19.
Table 19 — Long-term Net Charge-off Ratio Targets
         
    Long-term Targets(1)
 
Middle market C&I
    0.20% - 0.30%  
Middle market CRE
    0.15% - 0.25%  
Small business C&I and CRE
    0.50% - 0.60%  
Automobile loans
    0.65% - 0.75%  
Automobile direct financing leases
    0.50% - 0.60%  
Home equity loans and lines
    0.40% - 0.50%  
Residential loans
    0.15% +/-      
Total portfolio
    0.35% - 0.45%  
(1)  Assumes loan and lease portfolio mix comparable to December 31, 2006, and stable economic environment.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 20 — Net Loan and Lease Charge-offs
                                               
    At December 31,
 
(in thousands of dollars)   2006   2005   2004   2003   2002
 
Net charge-offs by loan and lease type:
                                       
 
Commercial:
                                       
   
Middle market commercial and industrial
  $ 6,318     $ 13,578     $ 1,920     $ 75,803     $ 104,703  
     
Construction
    3,553       135       2,465       2,928       4,216  
     
Commercial
    2,555       3,910       5,506       5,019       11,968  
 
   
Middle market commercial real estate
    6,108       4,045       7,971       7,947       16,184  
   
Small business commercial and industrial and commercial real estate
    15,225       11,951       5,566       11,625       14,516  
 
 
Total commercial
    27,651       29,574       15,457       95,375       135,403  
 
 
Consumer:
                                       
     
Automobile loans
    8,330       11,988       28,574       40,266       39,115  
     
Automobile leases
    10,445       11,664       10,837       5,728       1,431  
 
   
Automobile loans and leases
    18,775       23,652       39,411       45,994       40,546  
   
Home equity
    21,854       17,619       15,074       12,114       11,840  
   
Residential mortgage
    4,505       2,332       1,760       832       872  
   
Other loans
    9,591       6,880       6,833       7,494       8,251  
 
 
Total consumer
    54,725       50,483       63,078       66,434       61,509  
 
Total net charge-offs
  $ 82,376     $ 80,057     $ 78,535     $ 161,809     $ 196,912  
 
 
Net charge-offs — annualized percentages:
                                       
 
Commercial:
                                       
   
Middle market commercial and industrial
    0.11 %     0.28 %     0.04 %     1.64 %     2.18 %
     
Construction
    0.29       0.01       0.17       0.24       0.37  
     
Commercial
    0.09       0.20       0.29       0.28       0.72  
 
   
Middle market commercial real estate
    0.15       0.11       0.24       0.26       0.57  
   
Small business commercial and industrial and commercial real estate
    0.63       0.54       0.28       0.65       0.88  
 
 
Total commercial
    0.23       0.28       0.16       1.01       1.46  
 
 
Consumer:
                                       
     
Automobile loans
    0.40       0.59       1.25       1.24       1.43  
     
Automobile leases
    0.51       0.48       0.49       0.40       0.32  
 
   
Automobile loans and leases
    0.46       0.53       0.88       0.98       1.27  
   
Home equity
    0.44       0.37       0.36       0.36       0.40  
   
Residential mortgage
    0.10       0.06       0.05       0.04       0.06  
   
Other loans
    2.18       1.79       1.74       1.76       1.55  
 
 
Total consumer
    0.39       0.37       0.51       0.63       0.76  
 
Net charge-offs as a % of average loans
    0.32 %     0.33 %     0.35 %     0.81 %     1.13 %
 
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.
Market Risk
Market risk represents the risk of loss due to changes in market values of assets and liabilities. We incur market risk in the normal course of business through exposures to market interest rates, foreign exchange rates, equity prices, credit spreads and expected lease residual values. We have identified two primary sources of market risk: interest rate risk and price risk. Interest rate risk is our primary market risk.
Interest Rate Risk
Interest rate risk results from timing differences in the re-pricing and maturities of assets and liabilities, and changes in relationships between market interest rates and the yields on assets and rates on liabilities, as well as from the impact of

40


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to terminate certificates of deposit (CDs) before maturity.
Our board of directors establishes broad policies and operating limits with respect to interest rate risk. Our MRC establishes specific operating guidelines within the parameters of the board of directors’ policies. In general, we seek to minimize the impact of changing interest rates on net interest income and the economic values of assets and liabilities. Our MRC regularly monitors the level of interest rate risk sensitivity to ensure compliance with board of directors approved risk limits.
Interest rate risk management is a dynamic process that encompasses monitoring loan and deposit flows, investment and funding activities, and assessing the impact of the changing market and business environments. Effective management of interest rate risk begins with understanding the interest rate characteristics of assets and liabilities and determining the appropriate interest rate risk posture given market expectations and policy objectives and constraints.
Interest rate risk modeling is performed monthly. Two broad approaches to modeling interest rate risk are employed: income simulation and economic value analysis. An income simulation analysis is used to measure the sensitivity of forecasted net interest income to changes in market rates over a one-year time horizon. Although bank owned life insurance and automobile operating lease assets are classified as non-interest earning assets, and the income from these assets is in non-interest income, these portfolios are included in the interest sensitivity analysis because both have attributes similar to fixed-rate interest earning assets. The economic value of equity (EVE) is calculated by subjecting the period-end balance sheet to changes in interest rates, and measuring the impact of the changes on the values of the assets and liabilities. EVE serves as a complement to income simulation modeling as it provides risk exposure estimates for time periods beyond the one-year simulation horizon. Similar to income simulation modeling, EVE analysis also includes the risks of bank owned life insurance. EVE also considers the value sensitivity of the mortgage servicing asset and associated hedges.
The models used for these measurements take into account prepayment speeds on mortgage loans, mortgage-backed securities, and consumer installment loans, as well as cash flows of other loans and deposits. Balance sheet growth assumptions are also considered in the income simulation model. The models include the effects of derivatives, such as interest rate swaps, interest rate caps, floors, and other types of interest rate options, and account for changes in relationships among interest rates (basis risk).
During 2006, we completed a review of the behavior of our core deposits, given current market conditions, including the level of interest rates and competitive forces. The review was designed to improve our understanding of the rate responsiveness and balance runoff characteristics of these deposits. The review resulted in changes in assumptions regarding the projected rate responsiveness and balance behaviors of non-maturity deposits that are critical inputs to our asset-liability model. In general, we have concluded that the average lives of certain types of deposits are likely to be modestly shorter in the future than in the past. In addition, we believe that the responsiveness of deposit rates to changes in market interest rates will be higher in both rising and declining rate environments than it had been assumed to be previously. The changes in deposit assumptions resulted in a modeled increase in both NII and EVE exposures to rising rates.
The baseline scenario for income simulation analysis, with which all other scenarios are compared, is based on market interest rates implied by the prevailing yield curve as of the period end. Alternative interest rate scenarios are then compared with the baseline scenario. These alternative market rate scenarios include parallel rate shifts on both a gradual and immediate basis, movements in rates that alter the shape of the yield curve (e.g., flatter or steeper yield curve), and spot rates remaining unchanged for the entire measurement period. Scenarios are also developed to measure basis risk, such as the impact of LIBOR-based rates rising or falling faster than the prime rate.
The simulations for evaluating short-term interest rate risk exposure are scenarios that model gradual 100 and 200 basis point increasing and decreasing parallel shifts in interest rates over the next 12-month period beyond the interest rate change implied by the current yield curve. The table below shows the results of the scenarios as of December 31, 2006, and December 31, 2005. All of the positions were well within the board of directors’ policy limits.
Table 21 — Net Interest Income at Risk
                                 
    Net Interest Income at Risk (%)
 
Basis point change scenario
    -200       -100       +100       +200  
 
Board policy limits
    -4.0 %     -2.0 %     -2.0 %     -4.0 %
 
December 31, 2006
    0.0 %     0.0 %     -0.2 %     -0.4 %
December 31, 2005
    -1.3 %     -0.5 %     +0.1 %     +0.3 %

41


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
The primary simulations for EVE at risk assume an immediate and parallel increase in rates of +/- 100 and +/- 200 basis points beyond any interest rate change implied by the current yield curve. The table below outlines the results compared to the previous year-end and policy limits. All of the positions were within the board of directors’ policy limits.
Table 22 — Economic Value of Equity at Risk
                                 
    Economic Value of Equity at Risk (%)
 
Basis point change scenario
    -200       -100       +100       +200  
 
Board policy limits
    -12.0 %     -5.0 %     -5.0 %     -12.0 %
 
December 31, 2006
    +0.5 %     +1.4 %     -4.7 %     -11.3 %
December 31, 2005
    -0.8 %     +0.5 %     -2.5 %     -6.2 %
Price Risk
Price risk represents the risk of loss arising from adverse movements in the prices of financial instruments that are carried at fair value and are subject to mark-to-market accounting. We have price risk from trading securities, which includes instruments to hedge MSRs. We also have price risk from securities owned by our broker-dealer activities, the foreign exchange positions, investments in private equity limited partnerships and marketable equity securities held by our insurance subsidiaries. We have established loss limits on the trading portfolio and on the amount of foreign exchange exposure that can be maintained and the amount of marketable equity securities that can be held by the insurance subsidiaries.
Liquidity Risk
The objective of effective liquidity management is to ensure that cash flow needs can be met on a timely basis at a reasonable cost under both normal operating conditions and unforeseen circumstances. The liquidity of the Bank, our primary subsidiary, is used to originate loans and leases and to repay deposit and other liabilities as they become due or are demanded by customers. Liquidity risk arises from the possibility that funds may not be available to satisfy current or future commitments based on external macro market issues, asset and liability activities, investor perception of financial strength, and events unrelated to the company such as war, terrorism, or financial institution market specific issues.
Liquidity policies and limits are established by our board of directors, with operating limits set by our MRC, based upon analyses of the ratio of loans to deposits, the percentage of assets funded with non-core or wholesale funding and the amount of liquid assets available to cover non-core funds maturities. In addition, guidelines are established to ensure diversification of wholesale funding by type, source, and maturity and provide sufficient balance sheet liquidity to cover 100% of wholesale funds maturing within a six-month time period. A contingency funding plan is in place, which includes forecasted sources and uses of funds under various scenarios in order to prepare for unexpected liquidity shortages, including the implications of any rating changes. Our MRC meets monthly to identify and monitor liquidity issues, provide policy guidance, and oversee adherence to, and the maintenance of, an evolving contingency funding plan. We believe that sufficient liquidity exists to meet the funding needs of the Bank and the parent company.
Sources of Liquidity
Our primary source of funding for the Bank is core deposits from retail and commercial customers. As of December 31, 2006, these core deposits, of which our Regional Banking line of business provided 93%, funded 56% of total assets. The types and sources of deposits by business segment at December 31, 2006, are detailed in Table 23. At December 31, 2006, total core deposits represented 79% of total deposits, down slightly from 80% at the end of the prior year.
Core deposits are comprised of interest bearing and non-interest bearing demand deposits, savings and other domestic time deposits, consumer certificates of deposit both over and under $100,000, and non-consumer certificates of deposit less than $100,000. Other domestic time deposits are comprised primarily of IRA deposits and public fund certificates of deposit less than $100,000. Brokered time deposits represent funds obtained by or through a deposit broker that were issued in denominations of $100,000 or more and, in turn, participated by the broker to its customers in denominations of $100,000 or less. Negotiable certificates of deposit represent large denomination certificates of deposit (generally $ million or more) that can be sold but cannot be cashed in before maturity. Foreign deposits are interest bearing and all mature in one year or less.
Domestic time deposits of $100,000 or more, brokered deposits and negotiable CDs totaled $4.5 billion at the end of 2006 and $4.1 billion at the end of 2005. The contractual maturity of these deposits at December 31, 2006 was as follows: $1.8 billion in

42


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
three months or less, $0.5 billion in three months through six months, $0.3 billion after six months through twelve months, and $1.9 billion after twelve months.
Demand deposit overdrafts that have been reclassified as loan balances were $12.5 million and $11.9 million at December 31, 2006 and 2005, respectively.
Sources of wholesale funding include domestic time deposits of $100,000 or more, brokered deposits and negotiable CDs, deposits in foreign offices, short-term borrowings, Federal Home Loan Bank (FHLB) advances, other long-term debt and subordinated notes. At December 31, 2006, total wholesale funding was $11.5 billion, unchanged from December 31, 2005. The $11.5 billion portfolio at December 31, 2006, had a weighted average maturity of 4.2 years. We are a member of the FHLB of Cincinnati, which provides funding to members through advances. These advances carry maturities from one month to 20 years. At December 31, 2006, our wholesale funding includes $1.0 billion of advances from the FHLB. All FHLB borrowings are collateralized with mortgage-related assets such as residential mortgage loans and home equity loans. To provide further liquidity, we have a $6.0 billion domestic bank note program with $2.8 billion available for future issuance under this program as of December 31, 2006. This program enables us to issue notes with maturities from one month to 30 years.
Table 23 — Deposit Composition
                                                                                     
    At December 31,
 
(in millions of dollars)   2006   2005   2004   2003   2002
 
By Type
                                                                               
   
Demand deposits — non-interest bearing
  $ 3,616       14.4 %   $ 3,390       15.1 %   $ 3,392       16.3 %   $ 2,987       16.2 %   $ 3,058       17.5 %
   
Demand deposits — interest bearing
    7,751       30.9       7,380       32.9       7,786       37.5       6,411       34.7       5,390       30.8  
   
Savings and other domestic time deposits
    2,986       11.9       3,094       13.8       3,503       16.9       3,591       19.4       3,546       20.3  
   
Certificates of deposit less than $100,000
    5,365       21.4       3,988       17.8       2,755       13.3       2,731       14.8       3,753       21.4  
 
 
Total core deposits
    19,718       78.6       17,852       79.6       17,436       84.0       15,720       85.1       15,747       90.0  
 
 
Domestic time deposits of $100,000 or more
    1,192       4.8       887       4.0       794       3.8       520       2.8       240       1.4  
 
Brokered deposits and negotiable CDs
    3,346       13.4       3,200       14.3       2,097       10.1       1,772       9.6       1,093       6.2  
 
Deposits in foreign offices
    792       3.2       471       2.1       441       2.1       475       2.5       419       2.4  
 
Total deposits
  $ 25,048       100.0 %   $ 22,410       100.0 %   $ 20,768       100.0 %   $ 18,487       100.0 %   $ 17,499       100.0 %
 
Total core deposits:
                                                                               
 
Commercial
  $ 6,063       30.7 %   $ 5,352       30.0 %   $ 5,294       30.4 %   $ 4,255       27.1 %   $ 3,981       25.3 %
 
Personal
    13,655       69.3       12,500       70.0       12,142       69.6       11,465       72.9       11,766       74.7  
 
Total core deposits
  $ 19,718       100.0 %   $ 17,852       100.0 %   $ 17,436       100.0 %   $ 15,720       100.0 %   $ 15,747       100.0 %
 
 
By Business Segment(1)
                                                                               
 
Regional Banking:
                                                                               
   
Central Ohio
  $ 4,984       19.9 %   $ 4,521       20.2 %                                                
   
Northern Ohio
    3,572       14.3       3,498       15.6                                                  
   
Southern Ohio/Kentucky
    2,276       9.1       1,951       8.7                                                  
   
Eastern Ohio
    1,717       6.9       578       2.6                                                  
   
West Michigan
    2,757       11.0       2,791       12.5                                                  
   
East Michigan
    2,420       9.7       2,264       10.1                                                  
   
West Virginia
    1,514       6.0       1,464       6.5                                                  
   
Indiana
    819       3.3       728       3.2                                                  
   
Mortgage and equipment leasing groups
    172       0.7       162       0.7                                                  
                                     
 
Regional Banking
    20,231       80.9       17,957       80.1                                                  
 
Dealer Sales
    59       0.2       65       0.3                                                  
 
Private Financial and Capital Markets Group
    1,162       4.6       1,180       5.3                                                  
 
Treasury/Other(2)
    3,596       14.3       3,208       14.3                                                  
                                     
Total deposits
  $ 25,048       100.0 %   $ 22,410       100.0 %                                                
                                     
(1)  Prior period amounts have been reclassified to conform to the current period business segment structure.
 
(2)  Comprised largely of brokered deposits and negotiable CDs.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 24 — Federal Funds Purchased and Repurchase Agreements
                                         
    At December 31,
 
(in millions of dollars)   2006   2005   2004   2003   2002
 
Balance at year end
  $ 1,632     $ 1,820     $ 1,124     $ 1,378     $ 2,459  
Weighted average interest rate at year-end
    4.25 %     3.46 %     1.31 %     0.73 %     1.49 %
Maximum amount outstanding at month-end during the year
  $ 2,366     $ 1,820     $ 1,671     $ 2,439     $ 2,504  
Average amount outstanding during the year
    1,822       1,319       1,356       1,707       2,072  
Weighted average interest rate during the year
    4.02 %     2.41 %     0.88 %     1.22 %     1.98 %
Other potential sources of liquidity include the sale or maturity of investment securities, the sale or securitization of loans, and the issuance of common and preferred securities. The Bank also has access to the Federal Reserve’s discount window. At December 31, 2006, a total of $3.1 billion of commercial loans had been pledged to secure potential future borrowings through this facility.
At December 31, 2006, the portfolio of investment securities totaled $4.4 billion, of which $1.5 billion was pledged to secure public and trust deposits, interest rate swap agreements, U.S. Treasury demand notes, and securities sold under repurchase agreements. The composition and maturity of these securities are presented in Table 25. Another source of liquidity is non-pledged securities, which decreased to $2.7 billion at December 31, 2006, from $3.1 billion at December 31, 2005.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 25 — Investment Securities
                         
    At December 31,
 
(in thousands of dollars)   2006   2005   2004
 
U.S. Treasury
  $ 1,856       $23,675       $25,136  
Federal agencies
    1,431,410       1,615,488       1,945,762  
Other
    2,929,658       2,887,357       2,268,047  
 
Total investment securities
    $4,362,924       $4,526,520       $4,238,945  
 
                             
    Amortized        
    Cost   Fair Value   Yield(1)
 
U.S. Treasury
                       
   
Under 1 year
  $ 800     $ 800       5.60 %
   
1-5 years
    1,046       1,056       5.59  
   
6-10 years
                 
   
Over 10 years
                 
 
Total U.S. Treasury
    1,846       1,856       5.59  
 
Federal agencies
                       
 
Mortgage backed securities
                       
   
Under 1 year
    1,848       1,847       4.82  
   
1-5 years
    9,560       9,608       5.01  
   
6-10 years
    4,353       4,355       4.98  
   
Over 10 years
    1,261,423       1,265,651       5.76  
 
 
Total mortgage-backed Federal agencies
    1,277,184       1,281,461       5.75  
 
 
Other agencies
                       
   
Under 1 year
                 
   
1-5 years
    149,819       149,853       5.13  
   
6-10 years
    98       96       4.03  
   
Over 10 years
                 
 
 
Total other Federal agencies
    149,917       149,949       5.13  
 
Total Federal agencies
    1,427,101       1,431,410       5.69  
 
 
Municipal securities
                       
   
Under 1 year
    42       42       7.69  
   
1-5 years
    10,553       10,588       5.76  
   
6-10 years
    165,624       165,229       5.84  
   
Over 10 years
    410,248       415,564       6.68  
 
Total municipal securities
    586,467       591,423       6.43  
 
Private label CMO
                       
   
Under 1 year
                 
   
1-5 years
                 
   
6-10 years
                 
   
Over 10 years
    586,088       590,062       6.13  
 
Total private label CMO
    586,088       590,062        
 
Asset backed securities
                       
   
Under 1 year
                 
   
1-5 years
    30,000       30,056       6.20  
   
6-10 years
                 
   
Over 10 years
    1,544,572       1,552,748       6.31  
 
Total asset backed securities
    1,574,572       1,582,804       6.31  
 
Other
                       
   
Under 1 year
    4,800       4,784       3.90  
   
1-5 years
    2,750       2,706       4.45  
   
6-10 years
                 
   
Over 10 years
    44       86        
   
Non-marketable equity securities
    150,754       150,754        
   
Marketable equity securities
    6,481       7,039       6.40  
 
Total other
    164,829       165,369       5.31  
 
Total investment securities
  $ 4,340,903     $ 4,362,924       6.09 %
 
(1)  Weighted average yields were calculated using amortized cost on a fully taxable equivalent basis, assuming a 35% tax rate.

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
The relatively short-term nature of our loans and leases also provides significant liquidity. As shown in Table 26, of the $12.4 billion total commercial loans at December 31, 2006, approximately 35% matures within one year. In addition, during 2006 and 2005, $0.7 billion and $0.4 billion, respectively, in indirect automobile loans were sold, with such sales representing another source of liquidity.
Table 26 — Maturity Schedule of Commercial Loans
                                           
    At December 31, 2006
 
    One Year   One to   After       Percent
(in millions of dollars)   or Less   Five Years   Five Years   Total   of Total
 
 
Commercial and industrial
  $ 2,911     $ 3,431     $ 1,508     $ 7,850       63.5 %
 
Commercial real estate — construction
    447       772       9       1,228       9.9  
 
Commercial real estate — commercial
    999       1,566       711       3,276       26.6  
 
Total
  $ 4,357     $ 5,769     $ 2,228     $ 12,354       100.0 %
 
 
Variable interest rates
  $ 4,182     $ 4,468     $ 1,896     $ 10,546       85.4 %
 
Fixed interest rates
    175       1,301       332       1,808       14.6  
 
Total
  $ 4,357     $ 5,769     $ 2,228     $ 12,354       100.0 %
 
Percent of total
    35.3 %     46.7 %     18.0 %     100.0 %        
Parent Company Liquidity
The parent company’s funding requirements consist primarily of dividends to shareholders, income taxes, funding of non-bank subsidiaries, repurchases of our stock, debt service, and operating expenses. The parent company obtains funding to meet obligations from dividends received from direct subsidiaries, net taxes collected from subsidiaries included in the Federal consolidated tax return, fees for services provided to subsidiaries, and the issuance of debt securities.
We intend to maintain the Bank’s risk-based capital ratios at levels at which the Bank would be considered to be “well capitalized” by regulators. As a result, the amount of dividends that can be paid to the parent company depends on the Bank’s capital needs. At December 31, 2006, the Bank had tier one and total risk-based capital in excess of the minimum level required to be considered to be “well-capitalized” of $143.2 million and $135.9 million, respectively. The bank could have declared and paid $0.7 million of additional dividends to the parent company at December 31, 2006 without regulatory approval.
To help meet any additional liquidity needs, we have an open-ended, automatic shelf registration statement filed and effective with the Securities and Exchange Commission, which permits us to issue an unspecified amount of debt or equity securities.
At December 31, 2006, the parent company had $412.7 million in cash or cash equivalents. There is approximately $350 million that we anticipate will be paid by the parent company in connection with the proposed acquisition of Sky Financial. Considering this potential obligation, and expected quarterly dividend payments, we believe the parent company has sufficient liquidity to meet its cash flow obligations for the foreseeable future.
Credit Ratings
Credit ratings by the three major credit rating agencies are an important component of our liquidity profile. Among other factors, the credit ratings are based on financial strength, credit quality and concentrations in the loan portfolio, the level and volatility of earnings, capital adequacy, the quality of management, the liquidity of the balance sheet, the availability of a significant base of core retail and commercial deposits, and our ability to access a broad array of wholesale funding sources. Adverse changes in these factors could result in a negative change in credit ratings and impact not only the ability to raise funds in the capital markets, but also the cost of these funds. In addition, certain financial on- and off-balance sheet arrangements contain credit rating triggers that could increase funding needs if a negative rating change occurs. Letter of credit commitments for marketable securities, interest rate swap collateral agreements, and certain asset securitization transactions contain credit rating provisions. (See the Liquidity Risks section in Item 1A of the 2006 Annual Report on Form 10-K for additional discussion.)

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Credit ratings as of December 31, 2006, for the parent company and the Bank remained unchanged from December 31, 2005, and were as follows:
Table 27 — Credit Ratings
                                   
    December 31, 2006
 
    Senior Unsecured   Subordinated    
    Notes   Notes   Short-Term   Outlook
 
Huntington Bancshares Incorporated
                               
  Moody’s Investor Service     A3       Baal       P-2       Stable  
  Standard and Poor’s     BBB+       BBB       A-2       Stable  
  Fitch Ratings     A       A-       F1       Stable  
The Huntington National Bank
                               
  Moody’s Investor Service     A2       A3       P-1       Stable  
  Standard and Poor’s     A-       BBB+       A-2       Stable  
  Fitch Ratings     A       A-       F1       Stable  
Off-Balance Sheet Arrangements
In the normal course of business, we enter into various off-balance sheet arrangements. These arrangements include financial guarantees contained in standby letters of credit issued by the Bank and commitments by the Bank to sell mortgage loans.
Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. Most of these arrangements mature within two years. Approximately 47% of standby letters of credit are collateralized and most are expected to expire without being drawn upon. There were $1.2 billion, and $1.1 billion of outstanding standby letters of credit at December 31, 2006, and December 31, 2005, respectively. Non-interest income was recognized from the issuance of these standby letters of credit of $12.1 million, and $11.1 million for the years ending December 31, 2006, and December 31, 2005, respectively. The carrying amount of deferred revenue related to standby letters of credit at December 31, 2006, was $4.3 million. Standby letters of credit are included in the determination of the amount of risk-based capital that we, and the Bank are required to hold.
The Bank enters into forward contracts relating to the mortgage banking business. At December 31, 2006, commitments to sell residential real estate loans totaled $319.9 million. These contracts mature in less than one year.
Through our credit process, we monitor the credit risks of outstanding standby letters of credit. When it is probable that a standby letter of credit will be drawn and not repaid in full, losses are recognized in provision for credit losses. We do not believe that off-balance sheet arrangements will have a material impact on our liquidity or capital resources.
Table 28 — Contractual Obligations
                                         
    At December 31, 2006
 
    One Year   1 to 3   3 to 5   More than    
(in millions of dollars)   or Less   Years   Years   5 Years   Total
 
Deposits without a stated maturity
  $ 15,055     $     $     $     $ 15,055  
Certificates of deposit and other time deposits
    6,498       2,125       494       876       9,993  
Other long-term debt
    98       660       409       1,062       2,229  
Short-term borrowings
    1,676                         1,676  
Subordinated notes
                152       1,135       1,287  
Federal Home Loan Bank advances
    200       400       397             997  
Operating lease obligations
    32       58       51       136       277  
Operational Risk
As with all companies, there is risk inherent in the day-to-day operations that could result in losses due to human error, inadequate or failed internal systems and controls, and external events. Risk Management through a combination of business units and centralized processes, has the responsibility to manage the risk for the company through a process that assesses the overall level of risk on a regular basis and identifies specific risks and the steps being taken to control them. Furthermore, a system of committees is established to provide guidance over the process and escalate potential concerns to senior management

47


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
on the Operational Risk Committee, executive management on the Risk Management Committee and the Risk Committee of the board of directors, as appropriate.
We continue to develop and enhance policies and procedures to control the elements of risk found in our processes. While we are not able to eliminate risk completely, our goal is to minimize the impact of a risk event and to be prepared to cover the result of it through insurance, earnings, and capital.
An enterprise risk group performs certain overarching operational risk activities. These include monitoring adherence to corporate policies governing risk, business continuity programs to assure that operations to serve our customers continue during emergency situations, and information security to monitor and address electronic and sensitive information threats for the company.
Capital
Capital is managed both at the Bank and on a consolidated basis. Capital levels are maintained based on regulatory capital requirements and the economic capital required to support credit, market, liquidity, and operational risks inherent in our business, and to provide the flexibility needed for future growth and new business opportunities. We place significant emphasis on the maintenance of a strong capital position, which promotes investor confidence, provides access to the national markets under favorable terms, and enhances business growth and acquisition opportunities. The importance of managing capital is also recognized and we continually strive to maintain an appropriate balance between capital adequacy and providing attractive returns to shareholders.
Shareholders’ equity totaled $3.0 billion at December 31, 2006. This balance represented a $0.5 billion increase during 2006, primarily reflecting the issuance of shares pursuant to the acquisition of Unizan.
At December 31, 2006, we had unused authority to repurchase up to 3.9 million common shares. This authorization may be used to help mitigate the dilutive earnings impact resulting from the issuance of stock options and restricted stock. All purchases under the current authorization will be made from time-to-time in the open market or through privately negotiated transactions depending on market conditions.
We evaluate several measures of capital, along with the customary three primary regulatory ratios: Tier 1 Risk-based Capital, Total Risk-based Capital, and Tier 1 Leverage.
The Federal Reserve Board, which supervises and regulates the parent, sets minimum capital requirements for each of these regulatory capital ratios. In the calculation of these risk-based capital ratios, risk weightings are assigned to certain asset and off-balance sheet items such as interest rate swaps, loan commitments, and securitizations. Our Tier 1 Risk-based Capital, Total Risk-based Capital, Tier 1 Leverage ratios and risk-adjusted assets for five years are shown in Table 29 and are well in excess of minimum levels established for “well capitalized” institutions of 6.00%, 10.00%, and 5.00%, respectively.
The Bank is primarily supervised and regulated by the OCC, which establishes regulatory capital guidelines for banks similar to those established for bank holding companies by the Federal Reserve Board. At December 31, 2006, the Bank had regulatory capital ratios in excess of “well capitalized” regulatory minimums.
Table 29 — Capital Adequacy
                                                   
    “Well-   At December 31,
    Capitalized”    
(in millions of dollars)   Minimums   2006   2005   2004   2003   2002
 
Total risk-weighted assets
          $ 31,155     $ 29,599     $ 29,542     $ 28,164     $ 27,030  
Ratios:
                                               
 
Tier 1 leverage ratio
    5.00 %     8.00 %     8.34 %     8.42 %     7.98 %     8.51 %
 
Tier 1 risk-based capital ratio
    6.00       8.93       9.13       9.08       8.53       8.34  
 
Total risk-based capital ratio
    10.00       12.79       12.42       12.48       11.95       11.25  
 
Tangible equity ratio / asset ratio
            6.87       7.19       7.18       6.79       7.22  
 
Tangible equity / risk-weighted assets ratio
            7.65       7.91       7.86       7.31       7.29  
Our tangible equity ratio at December 31, 2006, was 6.87%, down from 7.19% at the end of 2005. Contributing to the decline was the implementation of Statement No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans. This decreased equity by $83.0 million but had no effect on reported net income. This implementation contributed 21 basis points of the 32 basis point reduction in the tangible equity ratio from the end of last year. The remainder of the decline was due to the repurchase of shares during 2006 and the impact of the Unizan merger. We have targeted a tangible equity to asset

48


 

MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
ratio of 6.25%-6.50% given the current portfolio risk profile. Partially offsetting these negative impacts was the positive impact from retained earnings.
The decline in risk-based capital ratios from the year-ago period reflected same factors causing the decline in tangible equity to assets ratio, except that the impact of adopting Statement No. 158 has not been reflected in the risk-based capital, pending resolution by banking regulators of the capital treatment of this pronouncement.
Another measure of capital adequacy favored by one of the rating agencies is tangible common equity to risk-weighted assets. This measurement utilizes risk-weighted assets, as defined in the regulatory capital ratio. The tangible common equity to risk-weighted assets ratio at December 31, 2006, was 7.65%, down from 7.91% at the end of 2005. The ratio was impacted by the addition of higher risk-weighted assets during the year and by the repurchase of 16.0 million shares over this 12-month period.
ESTIMATING THE FINANCIAL IMPACT DUE TO THE UNIZAN MERGER
The merger with Unizan Financial Corp. (Unizan) was completed on March 1, 2006. At the time of acquisition, Unizan had assets of $2.5 billion, including $1.6 billion of loans and core deposits of $1.5 billion. Unizan results were only in consolidated results for 10 months of 2006. (See Significant Factor 1)
Given the impact of the merger on reported 2006 results, we believe that an understanding of the impacts of the merger is necessary to better understand underlying performance trends. When comparing post-merger period results to pre-merger periods, two terms relating to the impact of the Unizan merger on reported results are used:
  –  “Merger-related” refers to amounts and percentage changes representing the impact attributable to the merger.
 
  –  “Merger costs” represent expenses associated with merger integration activities, primarily systems conversion cost and employee retention compensation.
The following methodology has been implemented to estimate the approximate effect of the Unizan merger used to determine “merger-related” impacts.
Balance Sheet Items
For loans and leases, as well as core deposits, balances as of the acquisition date are pro-rated to the post-merger period being used in the comparison. For example, to estimate the impact on 2006 first quarter average balances, one-third of the closing date balance was used as those balances were in reported results for only one month of the quarter. Quarterly estimated impacts for the 2006 second, third and fourth quarter results were developed using this same pro-rata methodology. Full-year 2006 estimated results represent the annual average of each quarter’s estimate. This methodology assumes acquired balances will remain constant over time.
Income Statement Items
For income statement line items, Unizan’s actual full year 2005 results were used for pro-rating the impact on post-merger periods. For example, to estimate the 2006 first quarter impact of the merger on personnel costs, one-twelfth of Unizan’s full-year 2005 personnel costs was used. Full quarter and year-to-date estimated impacts for subsequent periods were developed using this same pro-rata methodology. This results in an approximate impact since the methodology does not adjust for any unusual items or seasonal factors in Unizan’s 2005 reported results, or synergies realized since the merger date. The one exception to this methodology relates to the amortization of intangibles expense where the actual post-merger amount was used.
Table 30 provides detail of changes to selected full-year 2006 reported results to quantify the estimated impact of the Unizan merger and the impact of all other factors using this methodology:

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MANAGEMENT’S DISCUSSION AND ANALYSIS
HUNTINGTON BANCSHARES INCORPORATED
Table 30 — Estimated Impact of Unizan Merger
2006 Twelve Months versus 2005 Twelve Months
                                                             
    Twelve Months Ended       Unizan    
    December 31,   Change       Other
            Merger   Merger    
    2006   2005   Amount   %   Related   Costs   Amount
 
Average Loans and Deposits (in millions)
                    &nbs