10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on November 15, 1999
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
QUARTERLY PERIOD ENDED September 30, 1999
Commission File Number 0-2525
HUNTINGTON BANCSHARES INCORPORATED
MARYLAND 31-0724920
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
41 SOUTH HIGH STREET, COLUMBUS, OHIO 43287
Registrant's telephone number (614) 480-8300
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
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There were 229,757,210 shares of Registrant's without par value common stock
outstanding on October 31, 1999.
PART I. FINANCIAL INFORMATION
1. FINANCIAL STATEMENTS (UNAUDITED)
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(1) See page 12 for detail of total loans and total deposits.
See notes to unaudited consolidated financial statements.
2
(1) See page 13 for detail of non-interest income and non-interest expense.
(2) Adjusted for stock dividends and stock splits, as applicable.
See notes to unaudited consolidated financial statements.
3
See notes to unaudited consolidated financial statements.
4
See notes to unaudited consolidated financial statements.
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
A. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements reflect all
adjustments, consisting of normal recurring accruals, which are, in the opinion
of management, necessary for a fair presentation of the consolidated financial
position, the results of operations, and cash flows for the periods presented.
These unaudited consolidated financial statements have been prepared according
to the rules and regulations of the Securities and Exchange Commission and,
therefore, certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been omitted. The Notes to the Consolidated Financial Statements
appearing in Huntington's 1998 Annual Report on Form 10-K should be read in
conjunction with these interim financial statements.
B. RECLASSIFICATIONS
Certain amounts in the prior year's financial statements have been
reclassified to conform to the 1999 presentation. These reclassifications had no
effect on net income.
C. COMPREHENSIVE INCOME
Comprehensive Income includes net income as well as certain items that
are reported directly within a separate component of stockholders' equity that
bypass net income. Currently, Huntington's only component of Other Comprehensive
Income is the unrealized gains (losses) on securities available for sale. The
related before and after tax amounts are as follows (in thousands):
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D. NEW ACCOUNTING PRONOUNCEMENTS
In September 1998, the FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities". This Statement (as amended by
Statement No. 137) establishes accounting and reporting standards requiring that
every derivative instrument be recorded in the balance sheet as either an asset
or liability measured at its fair value. The Statement requires that changes in
the derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows gains and losses from derivatives to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions for which
hedge accounting is applied.
Statement No. 133, as amended, is effective for fiscal years beginning
after September 15, 2000. It may be implemented earlier provided adoption occurs
as of the beginning of any fiscal quarter after issuance. The Statement cannot
be applied retroactively. Huntington expects to adopt Statement No. 133, as
amended, in the first quarter of 2001. Based on information available, the
impact of adoption is not expected to be material to the Consolidated Financial
Statements.
E. TRUST PREFERRED SECURITIES
In January 1997, Huntington Capital I ("the Trust"), a Delaware
statutory business trust owned by Huntington, issued $200 million of company
obligated mandatorily redeemable capital securities. The proceeds from the
issuance of the capital securities ($200 million) and common securities ($6.2
million) were used by the Trust to purchase from Huntington $206.2 million of
Floating Rate Junior Subordinated Debentures.
In September 1998, an additional $100 million of company obligated
mandatorily redeemable capital securities were issued by Huntington Capital II
("the Series B Trust"), a statutory business trust also owned by Huntington. The
proceeds, including $3.1 million of common securities purchased by Huntington,
were used by the Series B Trust to purchase from Huntington $103.1 million of
Series B Floating Rate Junior Subordinated Debentures.
The subordinated debentures are the sole assets of each trust and
Huntington owns all of the common securities of the trusts. Interest payments
made on the capital securities are reported as a component of interest expense
on long-term debt. The capital securities bear interest and mature as follows:
The net proceeds received by Huntington from the sale of the capital
securities were used for general corporate purposes.
7
F. SPECIAL CHARGE
In October 1998, Huntington announced several initiatives to strengthen
its financial performance. These initiatives included the realignment of the
banking network; the exit of underperforming product lines and delivery
channels; the reduction of 1,000 work force positions, or approximately 10% of
the total employee base; and other cost savings measures. As a result of the
above initiatives, Huntington incurred a special charge of $90 million in the
fourth quarter of 1998. Refer to Note 2 in the Notes to the Consolidated
Financial Statements appearing in Huntington's 1998 Annual Report on Form 10-K
for further information.
The table below summarizes the major components of the special charge,
as well as the related amounts applied against the reserve through September 30,
1999. Huntington expects that the remaining reserve of $21 million, which
represents estimated future cash outlays, will be substantially utilized by the
end of 1999.
8
G. EARNINGS PER SHARE
Basic earnings per share is the amount of earnings for the period
available to each share of common stock outstanding during the reporting period.
Diluted earnings per share is the amount of earnings available to each share of
common stock outstanding during the reporting period adjusted for the potential
issuance of common shares for stock options and the conversion impact of
convertible equity instruments.
The calculation of basic and diluted earnings per share for each of the
periods ended September 30, is as follows (in thousands, except per share
amounts):
Average common shares outstanding and the dilutive effect of stock options have
been adjusted for subsequent stock dividends and stock splits, as applicable.
H. LINES OF BUSINESS
Huntington segments its operations into five distinct lines of business:
Retail Banking; Corporate Banking; Dealer Sales; Private Financial Group; and
Treasury/Other. Line of business results are determined based upon Huntington's
business profitability reporting system, which assigns balance sheet and income
statement items to each of the business segments. The process is designed around
Huntington's organizational and management structure and accordingly, the
results are not necessarily comparable with similar information published by
other financial institutions. Results are revised periodically to reflect
enhancements to Huntington's profitability reporting system and changes in its
organizational structure. For a detailed description of the individual segments,
refer to Huntington's Management Discussion and Analysis.
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H. LINES OF BUSINESS - CONTINUED
10
11
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FINANCIAL REVIEW
(1) Balance at September 1999, excludes $25 million of business credit card and
$518 million of consumer credit card receivables, respectively, classified as
"held for sale".
12
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FINANCIAL REVIEW
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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OVERVIEW
Huntington Bancshares Incorporated (Huntington) is a multi-state bank
holding company headquartered in Columbus, Ohio. Its subsidiaries are engaged in
full-service commercial and consumer banking, mortgage banking, lease financing,
trust services, discount brokerage services, underwriting credit life and
disability insurance, issuing commercial paper guaranteed by Huntington, and
selling other insurance and financial products and services. Huntington's
subsidiaries operate domestically in offices located in Ohio, Michigan, Florida,
West Virginia, Indiana, and Kentucky. Huntington has foreign offices in the
Cayman Islands and Hong Kong.
In 1995, Congress passed the Private Securities Litigation Reform Act to
encourage corporations to provide investors with information about anticipated
future financial performance, goals, and strategies. The Act provides a safe
harbor for such disclosure, or in other words, protection from unwarranted
litigation if actual results are not the same as management's expectations. This
Form 10-Q, including Management's Discussion and Analysis of Financial Condition
and Results of Operations, contains forward-looking statements including certain
plans, expectations, goals, and projections--including without limitation those
relating to Huntington's Year 2000 readiness--that are subject to numerous
assumptions, risks, and uncertainties. Actual results could differ materially
from those contained in or implied by Huntington's statements due to a variety
of factors including:
o changes in economic conditions and movements in interest rates;
o competitive pressures on product pricing and services;
o success and timing of business strategies and successful integration of
acquired businesses;
o the nature, extent, and timing of governmental actions and reforms; and,
o risks of Year 2000 disruption and extended disruption of vital
infrastructure.
The management of Huntington encourages readers of this Form 10-Q to
understand forward-looking statements to be strategic objectives rather than
absolute targets of future performance. The following discussion and analysis of
the financial performance of Huntington for the third quarter of 1999 should be
read in conjunction with the financial statements, notes and other information
contained herein.
Huntington reported net income of $105.6 million for the third quarter
of 1999 versus $88.8 million one year ago. In these same periods, diluted
earnings per share increased 21.1%, from $.38 to $.46. For the first nine months
of the year, net income was $307.1 million, compared with $270.6 million in the
same period last year. Diluted earnings per share for the nine month periods was
$1.32 and $1.15, respectively, an increase of 14.8%. Return on average assets
(ROA) was 1.45% and 1.43% for the third quarter and first nine months of 1999,
respectively, compared with 1.28% and 1.36% for the same periods a year ago.
Return on average equity (ROE) increased to 19.07% in the recent quarter, versus
16.43% in the third quarter last year. On a year-to-date basis, ROE was 19.01%
in 1999 and 17.27% in 1998.
Huntington's "cash basis" diluted earnings per share, which excludes the
effect of goodwill and other intangible assets amortization, net of tax, rose to
$.49 in the recent three months, compared with $.41 per share in last year's
third quarter. Cash basis ROA and ROE, which are computed using cash basis
earnings as a percentage of average tangible assets and average tangible equity
were 1.59% and 29.54%, respectively. Under this same basis for the first nine
months of 1999, ROA was 1.57% and ROE was 29.90%. Huntington's efficiency ratio
for the quarter just ended was 51.02%, a 5.4 percentage point improvement from
one year ago.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
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Total assets were $29.0 billion at September 30, 1999, compared with
$27.4 billion twelve months ago. The increase was primarily the result of strong
loan growth, particularly in the consumer area. Loans held for sale increased
during the recent quarter due to the recently announced decision by Huntington
to sell its retail and corporate credit card receivables. The sale closed in
October 1999. Commercial loans, including non-residential real estate, were up
approximately 6.3% versus the third quarter one year ago. In this same period,
consumer loans grew nearly 10%, primarily in the areas of vehicle leasing and
home equity lending.
On the funding side of the balance sheet, average core deposits were
$17.1 billion in the recent quarter, representing a decline of 2% versus the
same three months of 1998. Retail certificates of deposit drove the decrease as
all other categories were up from last year. Huntington continued to raise
short-term wholesale monies and issue unsecured medium-term notes as sources of
additional funding.
LINES OF BUSINESS
Huntington segments its operations into five distinct lines of business:
Retail Banking, Corporate Banking, Dealer Sales, Private Financial Group, and
Treasury/Other. Line of business results are determined based upon Huntington's
business profitability reporting system, which assigns balance sheet and income
statement items to each of the business segments. The process is designed around
Huntington's organizational and management structure, and accordingly, the
results are not necessarily comparable to similar information published by other
financial institutions. Below is a discussion of the business segment results,
which can be found in the notes to the unaudited consolidated financial
statements.
Retail Banking - Retail Banking net income was $48.2 million and $132.7 million
for the third quarter and the first nine months of 1999, respectively. This
represents a 47.2% and 39.1% increase, respectively, over 1998. Non-interest
income for the recent quarter increased 24.1% over the same period a year ago
with strength in service charges, brokerage and insurance income, and electronic
banking income. Mortgage banking revenues were off 17.4% as higher market rates
curtailed new production. Non-interest expenses were flat versus the comparable
periods of 1998. This segment contributed 43% of Huntington's year-to-date 1999
net income and comprised 31% of its total loan portfolio.
Corporate Banking - Corporate Banking posted net income of $32.4 million for the
third quarter, a 5.4% increase over 1998. For the first nine months, net income
was $95.6 million versus $84.7 million one year ago. The larger increase
year-to-date was the result of solid loan and deposit growth in the first half
of the year. The recent quarter's performance was impacted by certain paydowns
of significant larger credits. This segment contributed 31% of Huntington's
third quarter earnings and represented 35% of the total loan portfolio.
Dealer Sales - Net income totaled $21.7 million and $54.2 million for the recent
quarter and year-to-date periods, respectively, up 56.7% and 34.2% from one year
ago. Increased vehicle leasing volumes pushed net interest income higher.
Tighter expense control also helped to mitigate weakness in non-interest income.
This business line totaled 21% of Huntington's net income in the recent three
months and 30% of its outstanding loans.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
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Private Financial Group - The Private Financial Group achieved net income for
the quarter just ended of $5.3 million, 9.3% lower than the year-ago quarter,
and $17.1 million for the first nine months, an increase of 3.2% over the same
period last year. Net interest income for the quarter declined 13.5% due to
lower loan and deposit volumes. Non-interest income increased for the same
period 12.7% primarily due to increases in service charges, trust revenue, and
credit card income. This segment represented 5% of Huntington's third quarter
1999 operating results and 3% of total loans at September 30, 1999.
Treasury/Other - This segment reported a net loss of $2.1 million for the recent
quarter and net income of $7.5 million for the nine months just ended. In
comparing third quarter 1999 results to the same period last year, the primary
difference was $10.6 million of securities gains in 1998 versus only $.5 million
in this quarter. In terms of the nine month results, the lower securities gains
and increased amortization of intangibles subsequent to the Florida branch
acquisition in June 1998 drove net income down versus last year.
RESULTS OF OPERATIONS
NET INTEREST INCOME
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Net interest income for the three and nine months ended September 30,
1999, was $268.4 million and $789.1 million, increases of 6.7% and 4.7%,
respectively, when compared with the same periods last year. The increase in the
recent quarter is primarily attributable to growth in earning assets, though the
net interest margin did increase modestly to 4.22%, compared with 4.18% in
1998's third quarter. Higher earning assets also drove the year-to-date
increase.
PROVISION FOR LOAN LOSSES
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The provision for loan losses is the charge to earnings that management
estimates to be necessary to maintain the allowance for loan losses at a level
adequate to absorb inherent losses in the loan and lease portfolios. The
provision for loan losses was $22.1 million in the third quarter of 1999, down
from $24.2 million one year ago. On a year-to-date basis, the provision was
$68.4 million, also down from $70.9 million in the first nine months of 1998.
Annualized net charge-offs as a percentage of average total loans were .39% and
.43% in the three and nine months just ended. Loan losses totaled .52% and .48%
in the same periods last year.
NON-INTEREST INCOME
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Excluding gains from securities transactions, non-interest income was
$115.1 million for the recent three months and $337.7 million for the first nine
months of the year. Substantial improvements were experienced in several
fee-based activities. Brokerage and insurance income increased 45.4% in the
quarter due to Huntington's growing network of licensed investment and insurance
representatives, coupled with an advertising campaign promoting the company's
proprietary annuity product. The 28.3% increase in service charges was the
result of higher fee income from retail deposit accounts and growth in sales of
cash management products targeted to small businesses. Electronic banking income
was up 23.7% primarily due to the increasing popularity of Huntington's check
card product, along with an expanded number of on-line
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
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banking customers. Income from Bank Owned Life Insurance was $9.4 million and
$28.2 million, respectively, in the three months and nine months ended September
30, 1999, compared with $8.1 million and $20.6 million for the same periods a
year ago. Included within other non-interest income for the recent nine month
period is $2.5 million of gains from the June 1998 sale of branch banking
offices in Michigan. Included in this category last year is a gain of $9.5
million from the June 1998 sale of Huntington's out-of-market credit card
portfolio.
Securities transactions netted gains of $.5 million in the quarter just
ended and $5.1 million year-to-date. Huntington sold a portion of its common
stock investment in Security First Technologies Corporation in the second
quarter of 1999 at a gain of $23 million. Substantially offsetting this gain
were losses from the sale of fixed-income investments as Huntington repositioned
the portfolio to improve returns.
NON-INTEREST EXPENSE
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Non-interest expense totaled $206.2 million in the third quarter, a
decrease of 2.7% from one year ago. For the first nine months of 1999,
non-interest expense totaled $610.4 million, a slight decrease from the same
period in 1998. Adjusting for last year's Florida branch acquisition, which
largely impacted only the second half of 1998, non-interest expense declined
approximately 5.5%. Also adjusted for the purchase acquisition, personnel costs
were down 6.3% and 5.5% for the recent three and nine month periods as
Huntington has substantially completed its planned staffing reductions.
Decreased costs for outside services, printing and supplies, telecommunications,
and legal and other professional services were the result of ongoing
corporate-wide efficiency initiatives. Increases in occupancy and equipment
expenses were the result of banking office additions and other strategic
spending, particularly in the state of Florida. Depreciation expense related to
Huntington's new operations center in Columbus, Ohio, also contributed to the
increase.
Huntington announced several strategic actions in 1998 that have
directly impacted the current year's results, including the closing and/or sale
of approximately 33 underperforming banking offices. Huntington closed 26 and
sold 7 of these offices during the first nine months of 1999 with an additional
6 offices expected to be sold or closed prior to March 31, 2000. Huntington also
exited certain business activities, as discussed in the 1998 Annual Report on
Form 10-K.
YEAR 2000
The Year 2000 problem is the result of many existing computer programs
using only the last two-digits, as opposed to four digits, to indicate the year.
Such computer systems may be unable to recognize a year that begins with "20"
instead of "19". If not corrected, many computer programs could cause systems to
fail or other computer errors, leading to possible disruptions in operations or
creation of erroneous results.
Huntington engaged an independent consultant to establish a Year 2000
Program Management Office (PMO). The PMO organized Huntington's Year 2000
project management activities beyond the technical information services group
into all business units. The PMO helped create the methodology that is used in
every business unit and also afforded a quality assurance process with respect
to the actions taken to remedy the Year 2000 problem. A
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
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multitude of internal personnel from various disciplines throughout the
Huntington organization have been actively working on this project.
Huntington systems have been tested and adjusted for the Year 2000 date
change. Today all Huntington systems are performing under stringent Year 2000
scenarios. Huntington met the Year 2000 readiness goals and timetables
established by the Federal Financial Institutions Examination Council (FFIEC).
Huntington, in an enterprise-wide effort, has carefully adhered to its
Year 2000 Plan (the Plan), which addresses all systems, software, hardware, and
infrastructure components. In connection with implementation of the Plan,
business processes were assessed and validated throughout the organization. The
Plan identified and addressed "Mission Critical" and "Non-mission Critical"
components for Information Technology (IT) systems, Non-information Technology
(Non-IT) systems, and business processes. IT includes, for example, systems that
service loan and deposit customers. Non-IT systems include, among other things,
security systems, elevators, utilities, and voice/data communications. An
application, system, or process is Mission Critical if it is vital to the
successful continuance of a core business activity. Huntington has fully
completed the Plan's goals for both IT and Non-IT systems, following a five
phase approach recommended by federal bank regulators.
Beginning November 1, 1999, Huntington placed a freeze on all changes to
major business processes and systems that will be in effect until March 1, 2000.
The purpose of this freeze is to further protect the organization from Year 2000
disruption caused by changes that have not been validated as Year 2000 ready
being introduced to otherwise ready business processes and systems. A command
center has been established to address any incidents that may occur and
coordinate status reporting during this period. In addition, a call center
committee has been formed to handle the expected customer inquires and ensure
consistent communication is provided to all employees and customers. As part of
Huntington's contingency planning, staffing in all areas of the organization is
being coordinated through this command center to ensure adequate coverage in
case of an incident. Event drills are taking place in early December to train
employees to handle a sample failure scenario. While the company cannot predict
what will happen, Huntington is addressing a `worst case' scenario (i.e., loss
of power, loss of telecommunications, etc.) in its contingency planning.
Furthermore, Huntington has identified and performed "due diligence" on
approximately 350 vendors, with a focus on twenty-one vendors considered
"Mission Critical." Huntington has worked with each of these parties to test
transactions and/or interfaces between its processors, obtained appropriate
information from each party, and assessed each party's ability to be prepared
for the Year 2000. Huntington depends on various third-party vendors, suppliers,
and service providers. The activities undertaken by these third parties can vary
from processing and settlement of automated teller transactions to mortgage loan
processing. Huntington will be dependent on the continued service by its
vendors, suppliers, service providers, and ultimately its customers' continued
operations in order to avoid business interruptions. Any interruption in a third
party's ability to provide goods and services, such as issues with
telecommunication links, power, and transportation, could present problems to
Huntington's ability to service its customers.
Identifiable costs for the Year 2000 project incurred in the third
quarter and first nine months of 1999 were $1.9 million and $10.0 million,
respectively. Management estimates it will cost up to an additional $5 million
to keep its systems and business processes Year 2000 ready
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
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and to implement elements of its contingency plan, if necessary. These expenses
are not expected to materially impact operating results in any one period. The
estimates incorporate not only incremental third-party expenses for consultants
and others but also include salary and benefit costs of employees redeployed and
full implementation of the command center, regional command posts, and call
center. Also included are due diligence expenses related to monitoring
Huntington's vendors' and service providers' readiness.
Major business risks associated with the Year 2000 problem include, but
are not limited to, infrastructure failures, disruptions to the economy in
general, excessive cash withdrawal activity, closure of government offices,
foreign banks, and clearing houses, and increased non-performing loans and
credit losses in the event that borrowers fail to properly respond to the
problem, and other factors outside of Huntington's control. These risks, along
with unforeseen, and therefore unidentified circumstances involving Huntington's
systems, and the resulting possible inability to properly process core business
transactions and meet contractual servicing agreements, could expose Huntington
to loss of revenues, litigation, and asset quality deterioration.
The Year 2000 problem is unique in that it has never previously
occurred; thus, it is not possible to completely foresee or quantify the overall
or any specific financial or operational impact to Huntington or to third
parties which provide Mission Critical services to the company. Huntington has,
however, implemented several proactive processes to identify and mitigate risk
involving systems and processes over which it has control, including
strengthening its Business Resumption Plan for the Year 2000 by adding
alternatives for systems and networks in support of critical applications. The
modifications to Huntington's contingency plan are complete. Huntington's senior
management believes successful modifications to existing systems and conversions
to new systems will substantially reduce the risk of Year 2000 disruption.
INTEREST RATE RISK MANAGEMENT
Huntington seeks to achieve consistent growth in net interest income and
net income while managing volatility arising from shifts in interest rates. The
Asset and Liability Management Committee (ALCO) oversees financial risk
management, establishing broad policies and specific operating limits that
govern a variety of financial risks inherent in Huntington's operations,
including interest rate, liquidity, counterparty settlement, and market risks.
On and off-balance sheet strategies and tactics are reviewed and monitored
regularly by ALCO to ensure consistency with approved risk tolerances.
Interest rate risk management is a dynamic process, encompassing the
business flows onto the balance sheet, wholesale investment and funding, and the
changing market and business environment. Effective management of interest rate
risk begins with appropriately diversified investments and funding sources. To
accomplish its overall balance sheet objectives, Huntington regularly accesses a
variety of global markets--money, bond, and futures and options--as well as
numerous trading exchanges. In addition, dealers in over-the-counter financial
instruments provide availability of interest rate swaps as needed.
Measurement and monitoring of interest rate risk is an ongoing process.
A key element in this process is Huntington's estimation of the amount that net
interest income will change over a twelve to twenty-four month period given a
directional shift in interest rates. The income simulation model used by
Huntington captures all assets, liabilities, and off-balance sheet
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
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financial instruments, accounting for significant variables that may be affected
by interest rates. These include prepayment speeds on mortgages and consumer
installment loans, cash flows of loans and deposits, principal amortization on
revolving credit instruments, and balance sheet growth assumptions. The model
also captures embedded options, for example, interest rate caps, floors, or call
options, and accounts for changes in rate relationships, as various rate indices
lead or lag changes in market rates. Management believes, at any point in time,
the model provides a reasonably accurate estimate of Huntington's interest rate
risk exposure, even though these assumptions are inherently uncertain. This
information is regularly shared with the Board of Directors.
At September 30, 1999, the results of Huntington's interest sensitivity
analysis indicated that net interest income would be expected to decrease by
approximately 2% if rates rose 100 basis points and would drop an estimated 4%
in the event of a 200 basis point increase. Huntington is relatively neutral to
a 100 basis point drop in rates but would benefit 3% if rates declined 200 basis
points.
Active interest rate risk management necessitates the use of various
types of off-balance sheet financial instruments, primarily interest rate swaps.
Risk created by different indices on products, by unequal terms to maturity of
assets and liabilities, and by products that are appealing to customers but
incompatible with current risk limits can be eliminated or decreased in a cost
efficient manner by utilizing interest rate swaps. Often, the swap strategy has
enabled Huntington to lower the overall cost of raising wholesale funds.
Similarly, financial futures, interest rate caps and floors, options, and
forward rate agreements are used to control financial risk effectively.
Off-balance sheet instruments perform identically to similar cash instruments
but are often preferable because they require less capital while preserving
access to the marketplace.
The following table illustrates the approximate market values, estimated
maturities, and weighted average rates of the interest rate swaps used by
Huntington in its interest rate risk management program at September 30, 1999:
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
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As is the case with cash securities, the market value of interest rate
swaps is largely a function of the financial market's expectations regarding the
future direction of interest rates. Accordingly, current market values are not
necessarily indicative of the future impact of the swaps on net interest income.
This will depend, in large part, on the shape of the yield curve as well as
interest rate levels. Management made no assumptions regarding future changes in
interest rates with respect to the variable rate information and the indexed
amortizing swap maturities presented in the table above.
The pay rates on Huntington's receive-fixed swaps vary based on
movements in the applicable London interbank offered rate (LIBOR). Receive-fixed
asset conversion swaps and pay-fixed liability conversion swaps with notional
values of $950 million and $550 million, respectively, have embedded written
LIBOR-based call options. The portfolio of amortizing swaps consists primarily
of contracts that are indexed to the prepayment experience of a specified pool
of mortgage loans. As market interest rates change, the amortization of the
notional value of the swap will also change, generally slowing as rates increase
and accelerating when rates fall. Basis swaps are contracts that provide for
both parties to receive interest payments according to different rate indices
and are used to protect against changes in spreads between market rates. The
receive and pay amounts applicable to Huntington's basis swaps are based
predominantly on LIBOR.
The contractual interest payments are based on the notional values of
the swap portfolio. These notional values do not represent direct credit
exposures. At September 30, 1999, Huntington's credit risk from interest rate
swaps used for asset/liability management purposes was $59.6 million, which
represents the sum of the aggregate fair value of positions that have become
favorable to Huntington, including any accrued interest receivable due from
counterparties. In order to minimize the risk that a swap counterparty will not
satisfy its interest payment obligation under the terms of the contract,
Huntington performs credit reviews on all counterparties, restricts the number
of counterparties used to a select group of high quality institutions, obtains
collateral, and enters into formal netting arrangements. Huntington has never
experienced any past due amounts from a swap counterparty.
The total notional amount of off-balance sheet instruments used by
Huntington on behalf of customers (for which the related interest rate risk is
offset by third party contracts) was $1 billion at September 30, 1999. Total
credit exposure from such contracts is not material. These separate activities,
which are accounted for at fair value, are not a significant part of
Huntington's operations. Accordingly, they have been excluded from the above
discussion of off-balance sheet financial instruments and the related table.
CREDIT RISK
Huntington's exposure to credit risk is managed through the use of
consistent underwriting standards that emphasize "in-market" lending. Highly
leveraged transactions as well as excessive industry and other concentrations
are avoided. The credit administration function employs extensive risk
management techniques, including forecasting, to ensure that loans adhere to
corporate policy and problem loans are promptly identified. These procedures
provide executive management with the information necessary to implement policy
adjustments where necessary, and take corrective actions on a proactive basis.
21
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
- --------------------------------------------------------------------------------
Non-performing assets consist of loans that are no longer accruing
interest, loans that have been renegotiated based upon financial difficulties of
the borrower, and real estate acquired through foreclosure. Commercial and real
estate loans are placed on non-accrual status and stop accruing interest when
collection of principal or interest is in doubt or generally when the loan is 90
days past due. When interest accruals are suspended, accrued interest income is
reversed with current year accruals charged to earnings and prior year amounts
generally charged off as a credit loss. Consumer loans are not placed on
non-accrual status; rather they are charged off in accordance with regulatory
statutes, which is generally no more than 120 days. A charge off may be delayed
in circumstances when collateral is repossessed and anticipated to sell at a
future date. Total non-performing assets were $93.3 million and $95.8 million,
respectively, at September 30, 1999, and 1998. As of the same dates,
non-performing loans represented .39% of total loans, while non-performing
assets as a percent of total loans and other real estate were .47% and .50%,
respectively. Loans past due ninety days or more but continuing to accrue
interest were $64.8 million at September 30, 1999, up only slightly from one
year ago.
The allowance for loan losses (ALL) is maintained at a level considered
appropriate by management, based on its estimate of probable losses inherent in
the loan portfolio. The procedures employed by Huntington to evaluate the
adequacy of the ALL include an analysis of specific credits and the application
of relevant reserve factors that represent relative risk (based on portfolio
trends, current and historic loss experience, and prevailing economic
conditions) to specific portfolio segments. Specific reserves are established on
larger, impaired commercial and industrial and commercial real estate credits
and are based on discounted cash flow models using the loan's initial effective
rate or the fair value of the collateral for collateral-dependent loans.
Allocated reserves include management's assessment of portfolio performance,
internal controls, impacts from mergers and acquisitions, and other pertinent
risk factors. For analytical purposes, the ALL has been allocated to various
portfolio segments. However, the total ALL, less the portion attributable to
reserves as prescribed under provisions of SFAS No. 114, is available to absorb
losses from any segment of the portfolio. Unallocated reserves are based on
levels of criticized/classified assets, delinquencies in the accruing loan
portfolios, and the level of nonperforming loans. Total unallocated reserves
were 10% at the recent quarter end versus 12% one year ago. The reserve ratio
was 1.48% at the recent quarter end compared with 1.50% at the end of last
year's third quarter. As of September 30, 1999, the ALL covered non-performing
loans approximately 3.8 times and when combined with the allowance for other
real estate owned, was 316% of total nonperforming assets.
CAPITAL
Huntington places significant emphasis on the maintenance of strong
capital, which promotes investor confidence, provides access to the national
markets under favorable terms, and enhances business growth and acquisition
opportunities. Huntington also recognizes the importance of managing capital and
continually strives to maintain an appropriate balance between capital adequacy
and returns to shareholders. Capital is managed at each subsidiary based upon
the respective risks and growth opportunities, as well as regulatory
requirements. Huntington's ratio of average equity to average assets was 7.63%
in the recent quarter compared with 7.79% in the same three months of last year.
For the nine month period, the ratio was 7.54%, versus 7.86% in the first three
quarters of 1998.
22
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
- --------------------------------------------------------------------------------
Risk-based capital guidelines established by the Federal Reserve Board
set minimum capital requirements and require institutions to calculate
risk-based capital ratios by assigning risk weightings to assets and off-balance
sheet items, such as interest rate swaps and loan commitments. These guidelines
further define "well-capitalized" levels for Tier 1, Total Capital, and Leverage
ratio purposes at 6%, 10%, and 5%, respectively. At the recent quarter-end,
Huntington's Tier 1 risk-based capital ratio was 7.32%, its total risk-based
capital ratio was 10.62%, and its leverage ratio was 6.58%, each of which
exceeds the well-capitalized requirements. Huntington's bank subsidiary also had
regulatory capital ratios in excess of the levels established for
well-capitalized institutions.
Huntington's common stock repurchase program was reactivated in the
third quarter of 1998. In connection with the reinstatement of the program, the
Board of Directors also increased the number of shares authorized for repurchase
to 16.5 million (after adjusting for the ten percent stock dividend paid July
1999), up from approximately 3 million shares remaining when the plan was
suspended. The shares are to be purchased through open market and privately
negotiated transactions. Repurchased shares will be reserved for reissue in
connection with Huntington's dividend reinvestment, stock option, and other
benefit plans as well as for stock dividends and other corporate purposes. In
the first nine months of this year, Huntington repurchased approximately 2.6
million shares, leaving 12.6 million shares available for repurchase under the
program.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in market risk exposures that affect
the quantitative and qualitative disclosures presented in Huntington's Annual
Report on Form 10-K for the year ended December 31, 1998. Quantitative and
qualitative disclosures for the current period can be found on pages 19 through
21.
23
(1) Adjusted for stock dividends and stock splits, as applicable.
(2) Tangible or "Cash Basis" net income excludes amortization of goodwill and
other intangibles. Related asset amounts excluded from total assets and
shareholders' equity.
24
25
(1) Income before taxes and the provision for loan losses to net loan losses.
26
- ---------------------------------------------------------
(1) Fully tax equivalent yields are calculated assuming a 35% tax rate.
(2) Net loan rate includes loan fees, whereas individual loan components above
are shown exclusive of fees.
(3) Excludes nonrecurring interest rate swap adjustment of $9.2 million.
27
28
(1) Adjusted for stock dividends and stock splits, as applicable.
(2) Calculated assuming a 35% tax rate.
29
STOCK SUMMARY, KEY RATIOS AND STATISTICS
- --------------------------------------------------------------------------------
Note: Stock price quotations were obtained from NASDAQ.
- --------------------------------------
(1) Adjusted for stock dividends and stock splits, as applicable.
(2) Presented on a fully tax equivalent basis assuming a 35% tax rate.
30
PART II. OTHER INFORMATION
In accordance with the instructions to Part II, the other specified items in
this part have been omitted because they are not applicable or the information
has been previously reported.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3. ( i )( a ) Articles of Restatement of Charter,
Articles of Amendment to Articles of Restatement
of Charter, and Articles Supplementary previously
filed as Exhibit 3(i) to Annual Report on Form
10-K for the year ended December 31, 1993, and
incorporated herein by reference.
( i )( b ) Articles of Amendment to Articles of
Restatement of Charter -- previously filed as
Exhibit 3(i)(b) to Quarterly Report on Form 10-Q
for the quarter ended March 31, 1996, and
incorporated herein by reference.
( i )( c ) Articles of Amendment to Articles of
Restatement of Charter --previously filed as
Exhibit 3(i)(c) to Quarterly Report on Form 10-Q
for the quarter ended March 31, 1998, and
incorporated herein by reference.
( ii ) Amended and Restated Bylaws.
4. Instruments defining the Rights of Security
Holders:
Reference is made to Articles Fifth, Eighth and
Tenth of Articles of Restatement of Charter,
previously filed as Exhibit 3(i) to Annual Report
on Form 10-K for the year ended December 31, 1993,
and incorporated herein by reference, as amended
and supplemented by Articles of Amendment to
Articles of Restatement of Charter, previously
filed as Exhibit 3(i)(c) to Quarterly Report on
Form 10-Q for the quarter ended March 31, 1998,
and incorporated herein by reference. Also,
reference is made to Rights Plan, dated February
22, 1990, previously filed as Exhibit 1 to
Registration Statement on Form 8-A, and
incorporated herein by reference and to Amendment
No. 1 to the Rights Agreement, dated as of August
16, 1995, previously filed as Exhibit 4(b) to Form
8-K filed with the Securities and Exchange
Commission on August 28, 1995, and incorporated
herein by reference. Instruments defining the
rights of holders of long-term debt will be
furnished to the Securities and Exchange
Commission upon request.
27. Financial Data Schedule
99. Earnings to Fixed Charges
(b) Reports on Form 8-K
1. A report on Form 8-K, dated July 14, 1999, was
filed under report item numbers 5 and 7,
concerning Huntington's results of operations for
the second quarter 1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, Huntington
Bancshares Incorporated has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
Huntington Bancshares Incorporated
----------------------------------
(Registrant)
Date: November 15, 1999 /s/ Richard A. Cheap
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Richard A. Cheap
General Counsel and Secretary
Date: November 15, 1999 /s/ Anne W. Creek
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Anne W. Creek
Executive Vice President and Principal
Accounting Officer