Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

QUARTERLY PERIOD ENDED June 30, 2004

 

Commission File Number 0-2525

 


 

Huntington Bancshares Incorporated

 


 

Maryland   31-0724920

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

41 South High Street, Columbus, Ohio 43287

 

Registrant’s telephone number (614) 480-8300

 


 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

There were 229,685,385 shares of Registrant’s without par value common stock outstanding on July 31, 2004.

 



Table of Contents

Huntington Bancshares Incorporated

 

INDEX

 

Part I.

   Financial Information     

Item 1.

   Financial Statements (Unaudited)     
     Condensed Consolidated Balance Sheets at June 30, 2004, December 31, 2003, and June 30, 2003    3
     Condensed Consolidated Statements of Income for the three and six months ended June 30, 2004 and 2003    4
     Condensed Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2004 and 2003    5
     Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003    6
     Notes to Unaudited Condensed Consolidated Financial Statements    7

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    18

Item 3.

   Quantitative and Qualitative Disclosures about Market Risk    74

Item 4.

   Controls and Procedures    74

Part II.

   Other Information     

Item 2.

   Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities    75

Item 4.

   Submission of Matters to a Vote of Shareholders    75

Item 6.

   Exhibits and Reports on Form 8-K    76

Signatures

   77

 

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Part 1. Financial Information

Item 1. Financial Statements

Huntington Bancshares Incorporated

Condensed Consolidated Balance Sheets

 

(in thousands, except number of shares)


  

June 30,

2004


   

December 31,

2003


   

June 30,

2003


 
     (Unaudited)           (Unaudited)  

Assets

                        

Cash and due from banks

   $ 1,162,995     $ 899,689     $ 1,153,108  

Federal funds sold and securities purchased under resale agreements

     193,772       96,814       74,473  

Interest bearing deposits in banks

     24,009       33,627       44,906  

Trading account securities

     20,577       7,589       19,426  

Loans held for sale

     314,262       226,729       713,722  

Securities available for sale - at fair value

     4,988,270       4,925,232       3,702,761  

Investment securities held to maturity - fair value $3,224; $3,937 and $6,780, respectively

     3,169       3,828       6,593  

Loans and leases

     21,775,669       21,075,118       19,059,533  

Allowance for loan and lease losses

     (286,935 )     (299,732 )     (307,667 )
    


 


 


Net loans and leases

     21,488,734       20,775,386       18,751,866  
    


 


 


Operating lease assets

     888,612       1,260,440       1,672,608  

Bank owned life insurance

     944,892       927,671       906,823  

Premises and equipment

     354,534       349,712       332,916  

Goodwill and other intangible assets

     216,215       217,009       218,080  

Customers’ acceptance liability

     6,613       9,553       8,372  

Accrued income and other assets

     814,552       786,047       731,559  
    


 


 


Total Assets

   $ 31,421,206     $ 30,519,326     $ 28,337,213  
    


 


 


Liabilities

                        

Deposits

   $ 19,465,146     $ 18,487,395     $ 18,371,359  

Short-term borrowings

     1,130,830       1,452,304       918,771  

Federal Home Loan Bank advances

     1,270,455       1,273,000       1,273,000  

Other long-term debt

     4,557,373       4,544,509       3,508,397  

Subordinated notes

     1,011,506       990,470       496,666  

Company obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely junior subordinated debentures of the parent company

     —         —         300,000  

Allowance for unfunded loan commitments and letters of credit

     31,193       35,522       33,280  

Bank acceptances outstanding

     6,613       9,553       8,372  

Accrued expenses and other liabilities

     1,561,721       1,451,571       1,225,169  
    


 


 


Total Liabilities

     29,034,837       28,244,324       26,135,014  
    


 


 


Shareholders’ Equity

                        

Preferred stock - authorized 6,617,808 shares; none outstanding

     —         —         —    

Common stock - without par value; authorized 500,000,000 shares; issued 257,866,255 shares; outstanding 229,475,821; 229,008,088 and 228,660,038 shares, respectively

     2,482,069       2,483,542       2,483,105  

Less 28,390,434; 28,858,167 and 29,206,217 treasury shares, respectively

     (539,852 )     (548,576 )     (555,176 )

Accumulated other comprehensive income (loss)

     (27,204 )     2,678       40,817  

Retained earnings

     471,356       337,358       233,453  
    


 


 


Total Shareholders’ Equity

     2,386,369       2,275,002       2,202,199  
    


 


 


Total Liabilities and Shareholders’ Equity

   $ 31,421,206     $ 30,519,326     $ 28,337,213  
    


 


 


 

See notes to unaudited condensed consolidated financial statements

 

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Huntington Bancshares Incorporated

Condensed Consolidated Statements of Income

(Unaudited)

 

     Three Months Ended
June 30,


   

Six Months Ended

June 30,


 

(in thousands, except per share amounts)


   2004

    2003

    2004

   2003

 

Interest and fee income

                               

Loans and leases

                               

Taxable

   $ 268,409     $ 265,694     $ 538,771    $ 535,939  

Taxable-exempt

     444       675       950      1,409  

Securities

                               

Taxable

     43,926       37,014       88,072      74,139  

Taxable-exempt

     7,247       5,019       14,760      9,972  

Other

     4,141       8,923       7,545      15,880  
    


 


 

  


Total Interest Income

     324,167       317,325       650,098      637,339  
    


 


 

  


Interest expenses

                               

Deposits

     59,372       76,383       118,998      156,093  

Short-term borrowings

     2,789       4,313       6,102      9,872  

Federal Home Loan Bank advances

     8,098       5,634       16,139      11,219  

Subordinated notes and other long-term debt including preferred capital securities

     31,345       28,554       63,611      55,955  
    


 


 

  


Total Interest Expense

     101,604       114,884       204,850      233,139  
    


 


 

  


Net Interest Income

     222,563       202,441       445,248      404,200  

Provision for credit losses

     5,027       49,193       30,623      86,037  
    


 


 

  


Net Interest Income After Provision for Credit Losses

     217,536       153,248       414,625      318,163  
    


 


 

  


Operating lease income

     78,706       128,574       167,573      266,767  

Service charges on deposit accounts

     43,596       40,914       85,433      80,783  

Trust services

     16,708       15,580       33,031      30,491  

Brokerage and insurance income

     13,523       14,196       28,720      29,693  

Mortgage banking

     23,322       7,185       19,026      18,310  

Bank owned life insurance income

     11,309       11,043       21,794      22,180  

Gain on sales of automobile loans

     4,890       13,496       13,894      23,751  

Other service charges and fees

     10,645       11,372       20,158      21,710  

Securities gains (losses)

     (9,230 )     6,887       5,860      8,085  

Other

     24,659       27,704       50,278      48,105  
    


 


 

  


Total Non-Interest Income

     218,128       276,951       445,767      549,875  
    


 


 

  


Personnel costs

     119,715       105,242       241,339      218,331  

Operating lease expense

     62,563       102,939       133,273      214,527  

Outside data processing and other services

     17,563       16,104       36,025      32,683  

Equipment

     16,228       16,341       32,314      32,753  

Net occupancy

     16,258       15,377       33,021      31,986  

Professional services

     7,836       9,872       15,135      19,157  

Marketing

     8,069       8,454       15,908      15,080  

Telecommunications

     4,638       5,394       9,832      11,095  

Printing and supplies

     3,098       2,253       6,114      5,934  

Amortization of intangibles

     204       204       408      408  

Restructuring reserve releases

     —         (5,315 )     —        (6,315 )

Other

     25,981       20,168       44,438      36,873  
    


 


 

  


Total Non-Interest Expense

     282,153       297,033       567,807      612,512  
    


 


 

  


Income Before Income Taxes

     153,511       133,166       292,585      255,526  

Provision for income taxes

     43,384       36,676       78,285      67,306  
    


 


 

  


Net Income

   $ 110,127     $ 96,490     $ 214,300    $ 188,220  
    


 


 

  


Average Common Shares:

                               

Basic

     229,429       228,633       229,328      229,987  

Diluted

     232,659       230,572       232,787      231,684  

Per Common Share:

                               

Net Income - Basic

   $ 0.48     $ 0.42     $ 0.93    $ 0.82  

Net Income - Diluted

     0.47       0.42       0.92      0.81  

Cash Dividends Declared

     0.175       0.16       0.35      0.32  

 

See notes to unaudited condensed consolidated financial statements

 

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Huntington Bancshares Incorporated

Consolidated Statements of Changes in Shareholders’ Equity

 

(in thousands)


  Common Stock

    Treasury Shares

   

Accumulated

Other

Comprehensive

Income


   

Retained
Earnings


   

Total


 
  Shares

  Amount

    Shares

    Amount

       

Six Months Ended June 30, 2003 (Unaudited):

                                                 

Balance, beginning of period

  257,866   $ 2,484,421     (24,987 )   $ (475,399 )   $ 62,300     $ 118,471     $ 2,189,793  

Comprehensive Income:

                                                 

Net income

                                      188,220       188,220  

Unrealized net holding losses on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income

                              (4,391 )             (4,391 )

Unrealized losses on derivative instruments used in cash flow hedging relationships

                              (17,092 )             (17,092 )
                                             


Total comprehensive income

                                              166,737  
                                             


Cash dividends declared ($0.32 per share)

                                      (73,238 )     (73,238 )

Stock options exercised

        (1,316 )   118       1,902                       586  

Treasury shares purchased

              (4,300 )     (81,061 )                     (81,061 )

Other

              (37 )     (618 )                     (618 )
   
 


 

 


 


 


 


Balance, end of period (Unaudited)

  257,866   $ 2,483,105     (29,206 )   $ (555,176 )   $ 40,817     $ 233,453     $ 2,202,199  
   
 


 

 


 


 


 


Six Months Ended June 30, 2004 (Unaudited):

                                                 

Balance, beginning of period

  257,866   $ 2,483,542     (28,858 )   $ (548,576 )   $ 2,678     $ 337,358     $ 2,275,002  

Comprehensive Income:

                                                 

Net income

                                      214,300       214,300  

Unrealized net holding losses on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income

                              (52,165 )             (52,165 )

Unrealized gains on derivative instruments used in cash flow hedging relationships

                              22,283               22,283  
                                             


Total comprehensive income

                                              184,418  
                                             


Cash dividends declared ($0.35 per share)

                                      (80,302 )     (80,302 )

Stock options exercised

        (951 )   442       8,467                       7,516  

Other

        (522 )   26       257                       (265 )
   
 


 

 


 


 


 


Balance, end of period (Unaudited)

  257,866   $ 2,482,069     (28,390 )   $ (539,852 )   $ (27,204 )   $ 471,356     $ 2,386,369  
   
 


 

 


 


 


 


 

See notes to unaudited condensed consolidated financial statements.

 

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Huntington Bancshares Incorporated

Consolidated Statements of Cash Flows

(Unaudited)

 

     Six Months Ended June 30,

 

(in thousands)


   2004

    2003

 

Operating Activities

                

Net Income

   $ 214,300     $ 188,220  

Adjustments to reconcile net income to net cash provided by operating activities

                

Provision for credit losses

     30,623       86,037  

Depreciation on operating lease assets

     132,388       187,914  

Other depreciation and amortization

     38,995       42,209  

Deferred income tax expense

     66,243       31,479  

Increase in trading account securities

     (12,988 )     (19,185 )

Increase in mortgages held for sale

     (87,783 )     (185,343 )

Gains on sales of securities available for sale

     (5,860 )     (8,085 )

Gains on sales/securitizations of loans

     (15,407 )     (30,797 )

Restructuring reserve releases

     —         (6,315 )

Other, net

     (8,146 )     (68,002 )
    


 


Net Cash Provided by Operating Activities

     352,365       218,132  
    


 


Investing Activities

                

Decrease (increase) in interest bearing deposits in banks

     9,618       (7,606 )

Proceeds from:

                

Maturities and calls of investment securities held to maturity

     670       954  

Maturities and calls of securities available for sale

     544,419       945,534  

Sales of securities available for sale

     885,554       591,497  

Purchases of securities available for sale

     (1,457,477 )     (1,649,721 )

Proceeds from sales/securitizations of loans

     1,382,596       1,390,378  

Net loan and lease originations, excluding sales

     (2,234,989 )     (2,119,933 )

Net decrease in operating lease assets

     240,523       340,003  

Proceeds from sale of premises and equipment

     334       4,049  

Purchases of premises and equipment

     (29,298 )     (22,220 )

Proceeds from sales of other real estate

     6,460       4,872  
    


 


Net Cash Used for Investing Activities

     (651,590 )     (522,193 )
    


 


Financing Activities

                

Increase in deposits

     982,401       869,313  

Decrease in short-term borrowings

     (321,474 )     (1,222,245 )

Proceeds from issuance of subordinated notes

     148,830       —    

Maturity of subordinated notes

     (100,000 )     (250,000 )

Proceeds from Federal Home Loan Bank advances

     455       270,000  

Maturity of Federal Home Loan Bank advances

     (3,000 )     (10,000 )

Proceeds from issuance of long-term debt

     625,000       1,235,000  

Maturity of long-term debt

     (600,000 )     (225,000 )

Dividends paid on common stock

     (80,239 )     (73,714 )

Repurchases of common stock

     —         (81,061 )

Net proceeds from issuance of common stock

     7,516       586  
    


 


Net Cash Provided by Financing Activities

     659,489       512,879  
    


 


Change in Cash and Cash Equivalents

     360,264       208,818  

Cash and Cash Equivalents at Beginning of Period

     996,503       1,018,763  
    


 


Cash and Cash Equivalents at End of Period

   $ 1,356,767     $ 1,227,581  
    


 


Supplemental disclosures:

                

Income taxes paid

   $ 9,490     $ 65,859  

Interest paid

     206,500       247,126  

Non-cash activities

                

Residential mortgage loans securitized and retained in securities available for sale

     115,929       171,586  

Common stock dividends accrued not paid

     31,562       27,932  

 

See notes to unaudited condensed consolidated financial statements.

 

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Notes to Unaudited Condensed Consolidated Financial Statements

 

Note 1 – Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements of Huntington Bancshares Incorporated (Huntington) reflect all adjustments consisting of normal recurring accruals, which are, in the opinion of Management, necessary for a fair presentation of the consolidated financial position, the results of operations, and cash flows for the periods presented. These unaudited condensed consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission (SEC) and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (GAAP) have been omitted. The Notes to the Consolidated Financial Statements appearing in Huntington’s 2003 Annual Report on Form 10-K (2003 Form 10-K), which include descriptions of significant accounting policies, as updated by the information contained in this report, should be read in conjunction with these interim financial statements.

 

Certain amounts in the prior year’s financial statements have been reclassified to conform to the 2004 presentation.

 

For statement of cash flows purposes, cash and cash equivalents are defined as the sum of “Cash and due from banks” and “Federal funds sold and securities purchased under resale agreements”.

 

Note 2 – New Accounting Pronouncements

 

Emerging Issues Task Force Issue No. 03-1, The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments (EITF 03-1): The Emerging Issues Task Force reached a consensus about the criteria that should be used to determine when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. EITF 03-1 also included accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. EITF 03-1 will apply to the evaluation of other-than-temporary impairment in reporting periods beginning after June 15, 2004.

 

At June 30, 2004, Huntington had $3.3 billion of securities whose fair value was less than book value. The unrealized loss in these securities totaled $88.9 million. Of these securities, Huntington held $3.1 billion of securities, with an unrealized loss of $80.0 million, where the security cannot be contractually prepaid or where Huntington would recover substantially all of its cost if the securities were contractually prepaid. Management continues to evaluate its options with respect to adopting this new accounting guidance and cannot currently estimate the impact of adopting EITF 03-1.

 

Emerging Issues Task Force Issue No. 03-16, Accounting for Investment in Limited Liability Companies (EITF 03-16): The Task Force reached a consensus that an investment in a limited liability company (LLC) that maintains a “specific ownership account” for each investor should be viewed as similar to an investment in a limited partnership for purposes of determining whether a noncontrolling investment in an LLC should be accounted for using the cost method or the equity method. The current rules require a noncontrolling investment in a limited partnership to be accounted for under the equity method unless the interest is so minor that the limited partner may have virtually no influence over the partnership operating and financial policies. The guidance for evaluating an investment in a LLC should be applied for reporting periods beginning after June 15, 2004. The impact of EITF 03-16 is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.

 

SEC Staff Accounting Bulletin No. 105, Application of Accounting Principles to Loan Commitments (SAB 105): On March 9, 2004, the SEC issued SAB 105, which summarizes the views of the SEC staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments. Specifically, SAB 105 indicated that the fair value of loan commitments that are required to follow derivative accounting under FAS 133, Accounting for Derivative Instruments and Hedging Activities, should not consider the expected future cash flows related to the associated servicing of the future loan. Prior to SAB 105, Huntington did not consider the expected future cash flows related to the associated servicing in determining the fair value of loan commitments. The adoption of SAB 105 did not have a material effect on Huntington’s financial results.

 

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FASB Staff Position No. 106-2, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (FSP 106-2): In December 2003, a law was approved that expands Medicare benefits, primarily adding a prescription drug benefit for Medicare-eligible retirees beginning in 2006. The law also provides a federal subsidy to companies that sponsor postretirement benefit plans providing prescription drug coverage. FSP 106-2 was issued in May 2004 and supersedes FSP 106-1 issued in January 2004. FSP 106-2 specifies that any Medicare subsidy must be taken into account in measuring the employer’s postretirement health care benefit obligation and will also reduce the net periodic postretirement cost in future periods. The new guidance is effective for the reporting periods beginning on or after June 15, 2004. Accordingly, the postretirement benefit obligations and net periodic costs reported in the accompanying financial statements and notes do not reflect the impact of this legislation. The impact of this new pronouncement is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.

 

AICPA Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (SOP 03-3): In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued SOP 03-3 to address accounting for differences between the contractual cash flows of certain loans and debt securities and the cash flows expected to be collected when loans or debt securities are acquired in a transfer and those cash flow differences are attributable, at least in part, to credit quality. As such, SOP 03-3 applies to loans and debt securities acquired in purchase business combinations and does not apply to originated loans. The application of SOP 03-3 limits the interest income, including accretion of purchase price discounts, that may be recognized for certain loans and debt securities. Additionally, SOP 03-3 requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield or valuation allowance, such as the allowance for credit losses. Subsequent to the initial investment, increases in expected cash flows generally should be recognized prospectively through adjustment of the yield on the loan or debt security over its remaining life. Decreases in expected cash flows should be recognized as impairment. SOP 03-3 is effective for loans and debt securities acquired in fiscal years beginning after December 15, 2004, with early application encouraged. The impact of this new pronouncement is not expected to be material to Huntington’s financial condition, results of operations, or cash flows.

 

FASB Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure (FAS 148): FAS 148 was issued in December 2002, as an amendment of Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition to FAS 123’s fair value method of accounting for stock-based employee compensation. FAS 148 also amends the disclosure provisions of FAS 123 and Accounting Principles Board (APB) Opinion No. 28, Interim Financial Reporting (APB 28), to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While FAS 148 does not require companies to account for employee stock options using the fair value method, the disclosure provisions of FAS 148 are applicable to all companies with stock-based employee compensation, regardless of whether they account for that compensation using the fair value method of FAS 123 or the intrinsic value method of APB 25, which is the method currently used by Huntington. See note 11 for the disclosures.

 

Note 3 – Securities and Exchange Commission Investigation

 

As previously disclosed, the Securities and Exchange Commission (SEC) is conducting a formal investigation regarding certain financial accounting and disclosure matters, including certain matters that were the subject of prior restatements by Huntington. The SEC staff has notified Huntington that the staff is considering recommending to the SEC that it institute enforcement action against Huntington and certain of its senior officers for, among other possible matters, violations of various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933 in connection with certain financial accounting matters relating to fiscal years 2002 and earlier, and certain related disclosure matters.

 

Huntington is presently in negotiations with the staff of the SEC regarding a settlement of its investigation. Huntington’s chief executive officer has indicated he accepts responsibility in his position as the chief executive officer for matters that occur on his watch, and has indicated a willingness to negotiate a settlement with the SEC of these matters. Huntington expects that a settlement of this matter would involve the entry of an order requiring, among other possible matters, Huntington to comply with various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933, along with the imposition of a fine and other possible measures. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.

 

Huntington also remains in active dialogue with its bank regulators concerning these matters and is working diligently with the regulators to resolve them in a manner that permits it to proceed with its pending Unizan acquisition. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.

 

Donald R. Kimble, who joined Huntington earlier this year as executive vice president in the Finance area, has been named chief financial officer and controller. Prior to joining Huntington, Kimble was executive vice president and controller of AmSouth Bancorporation, and previously held various subsidiary chief financial officer or accounting positions at Bank One Corporation. Michael J. McMennamin and John D. Van Fleet have relinquished their positions of chief financial officer and controller, respectively. Both remain with the company.

 

8


Table of Contents

Note 4 – Pending Acquisition

 

On January 27, 2004, Huntington announced the signing of a definitive agreement to acquire Unizan Financial Corp. (Unizan), a financial holding company based in Canton, Ohio, with $2.7 billion of assets at December 31, 2003. Under the terms of the agreement, Unizan shareholders will receive 1.1424 shares of Huntington common stock, on a tax-free basis, for each share of Unizan. Based on the $23.10 closing price of Huntington’s common stock on January 26, 2004, this represented a price of $26.39 per Unizan share, and valued the transaction at approximately $587 million. Both boards unanimously approved the merger, and on May 25, 2004, Unizan shareholders approved the merger. Approval by Huntington shareholders is not required.

 

As reported on June 16, 2004, the Federal Reserve Board had informed Huntington that it had extended its review period to coordinate further with the staff of the SEC regarding the SEC’s ongoing formal investigation of Huntington and to complete its review of the Community Reinvestment Act aspects of the merger. Huntington remains in active dialogue with its bank regulators concerning these matters and is working diligently with the regulators to resolve them in a manner that permits it to proceed with its pending Unizan acquisition. No assurances, however, can be provided as to the ultimate timing or outcome of these matters (see Note 3 for additional discussion).

 

Huntington and Unizan are ready to close the merger, subject to the receipt of all necessary regulatory approvals. After the merger, Huntington also intends to purchase approximately 2.5 million common shares from time-to-time in the open market or through privately negotiated transactions depending on market conditions, to offset the dilutive effect of issuing shares to Unizan shareholders.

 

Note 5 – Stock Repurchase Plan

 

Effective April 27, 2004, the board of directors authorized a new share repurchase program (the 2004 Repurchase Program) which cancelled the 2003 Repurchase Program and authorized Management to repurchase not more than 7,500,000 shares of Huntington common stock. Any share repurchases will be made under this authorization. Purchases will be made from time-to-time in the open market or through privately negotiated transactions depending on market conditions. No share repurchases were made under the 2004 repurchase program.

 

Note 6 – Operating Lease Assets

 

Operating lease assets at June 30, 2004, December 31, 2003, and June 30, 2003, were as follows:

 

(in thousands)


   June 30,
2004


    December 31,
2003


    June 30,
2003


 

Cost of assets under operating leases

   $ 1,629,552     $ 2,136,502     $ 2,689,413  

Deferred lease origination fees and costs

     (1,033 )     (2,117 )     (44,586 )

Accumulated depreciation

     (739,907 )     (873,945 )     (972,219 )
    


 


 


Operating Lease Assets, Net

   $ 888,612     $ 1,260,440     $ 1,672,608  
    


 


 


 

Depreciation and residual losses at termination related to operating lease assets was $57.4 million and $91.4 million for the three months ended June 30, 2004 and 2003, respectively. For the respective six-month periods, depreciation and residual losses at termination was $121.3 million and $190.7 million.

 

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Table of Contents

Note 7 – Securities Available for Sale

 

Securities available for sale at June 30, 2004, December 31, 2003, and June 30, 2003 were as follows:

 

     June 30, 2004

   December 31, 2003

   June 30, 2003

(in thousands of dollars)


   Amortized
Cost


   Fair Value

   Amortized
Cost


   Fair Value

   Amortized
Cost


   Fair Value

U.S. Treasury

                                         

Under 1 year

   $ 796    $ 800    $ 1,374    $ 1,376    $ 327    $ 331

1-5 years

     24,480      24,404      31,356      31,454      38,930      39,543

6-10 years

     754      824      271,271      275,540      64,063      66,158

Over 10 years

     —        —        —        —        —        —  
    

  

  

  

  

  

Total U.S. Treasury

     26,030      26,028      304,001      308,370      103,320      106,032
    

  

  

  

  

  

Federal Agencies

                                         

Mortgage backed securities

                                         

1-5 years

     14,181      14,548      19,899      20,434      23,879      24,661

6-10 years

     155,460      155,628      198,755      201,995      248,896      254,564

Over 10 years

     1,352,082      1,331,790      1,593,139      1,595,594      1,668,613      1,699,875
    

  

  

  

  

  

Total Mortgage-Backed

     1,521,723      1,501,967      1,811,793      1,818,023      1,941,388      1,979,100
    

  

  

  

  

  

Other Federal Agencies

                                         

Under 1 year

     116,357      118,776      173,181      175,505      137,797      141,375

1-5 years

     728,472      719,339      585,561      593,662      294,977      313,029

6-10 years

     343,226      322,398      403,953      390,164      171,343      169,976

Over 10 years

     —        —        201      192      —        —  
    

  

  

  

  

  

Total Other Agencies

     1,188,055      1,160,512      1,162,896      1,159,523      604,117      624,380
    

  

  

  

  

  

Total U.S. Treasury and Other Federal Agencies

     2,735,808      2,688,507      3,278,690      3,285,916      2,648,825      2,709,512
    

  

  

  

  

  

Municipal Securities

                                         

Under 1 year

     6,679      6,731      6,594      6,663      6,639      6,728

1-5 years

     14,191      14,424      20,015      20,569      20,402      21,150

6-10 years

     69,861      68,928      69,511      71,013      52,995      54,707

Over 10 years

     311,972      303,309      332,181      334,188      219,011      223,072
    

  

  

  

  

  

Total Municipal Securities

     402,703      393,391      428,301      432,433      299,047      305,657
    

  

  

  

  

  

Private Label CMO

                                         

Under 1 year

     —        —        1,973      1,973      —        —  

1-5 years

     —        —        —        —        —        —  

6-10 years

     —        —        —        —        —        —  

Over 10 years

     585,920      577,013      388,933      388,684      197,080      198,617
    

  

  

  

  

  

Total Private Label CMO

     585,920      577,013      390,906      390,657      197,080      198,617
    

  

  

  

  

  

Asset Backed Securities

                                         

Under 1 year

     —        —        —        —        —        —  

1-5 years

     30,000      30,038      30,000      29,944      30,000      29,944

6-10 years

     11,187      11,339      20,000      19,984      —        —  

Over 10 years

     1,074,239      1,075,608      590,826      589,788      96,875      96,693
    

  

  

  

  

  

Total Asset Backed Securities

     1,115,426      1,116,984      640,826      639,716      126,875      126,637
    

  

  

  

  

  

Other

                                         

Under 1 year

     1,611      1,642      500      502      1,081      1,003

1-5 years

     9,703      9,877      7,169      7,346      8,605      8,641

6-10 years

     2,854      2,948      5,047      5,510      4,994      5,267

Over 10 years

     193,652      190,545      145,103      146,685      136,226      132,948

Retained interest in securitizations

     —        —        5,593      6,356      148,177      163,664

Marketable equity securities

     6,658      7,364      8,547      10,111      50,809      50,815
    

  

  

  

  

  

Total Other

     214,479      212,375      171,959      176,510      349,892      362,338
    

  

  

  

  

  

Total Securities Available for Sale

   $ 5,054,335    $ 4,988,270    $ 4,910,682    $ 4,925,232    $ 3,621,719    $ 3,702,761
    

  

  

  

  

  

 

The growth from year-end and the year-ago quarter primarily consisted of over 10-year variable-rate asset backed securities.

 

10


Table of Contents

Note 8 – Segment Reporting

 

Huntington has three distinct lines of business: Regional Banking, Dealer Sales, and the Private Financial Group (PFG). A fourth segment includes Huntington’s Treasury functions and capital markets activities and other unallocated assets, liabilities, revenue, and expense. Line of business results are determined based upon Huntington’s management reporting system, which assigns balance sheet and income statement items to each of the business segments. The process is designed around Huntington’s organizational and management structure and, accordingly, the results below are not necessarily comparable with similar information published by other financial institutions.

 

Management relies on “operating earnings” for review of performance and for critical decision making purposes. Operating earnings exclude the impact of the significant items listed in the reconciliation table below. See Note 12 for further discussions regarding Restructuring Reserves.

 

The following provides a brief description of the four operating segments of Huntington:

 

Regional Banking: This segment provides products and services to retail, business banking, and commercial customers. These products and services are offered in seven operating regions within the five states of Ohio, Michigan, West Virginia, Indiana, and Kentucky through the company’s traditional banking network. Each region is further divided into Retail and Commercial Banking units. Retail products and services include home equity loans and lines of credit, first mortgage loans, direct installment loans, business loans, personal and business deposit products, as well as sales of investment and insurance services. Retail products and services comprise 57% and 81% of total Regional Banking loans and deposits, respectively. These products and services are delivered to customers through banking offices, ATMs, Direct Bank—Huntington’s customer service center, and Web Bank at huntington.com. Commercial banking serves middle-market and commercial banking relationships, which use a variety of banking products and services including, commercial loans, international trade, cash management, leasing, interest rate protection products, capital market alternatives, 401(k) plans, and mezzanine investment capabilities.

 

Dealer Sales: This segment serves automotive dealerships within Huntington’s primary banking markets, as well as in Arizona, Florida, Georgia, Pennsylvania, and Tennessee. This segment finances the purchase of automobiles by customers of the automotive dealerships, purchases automobiles from dealers and simultaneously leases the automobiles under long-term direct financing leases, finances dealership floor plan inventories, real estate, or working capital needs, and provides other banking services to the automotive dealerships and their owners.

 

Private Financial Group: This segment provides products and services designed to meet the needs of the company’s higher net worth customers. Revenue is derived through trust, asset management, investment advisory, brokerage, insurance, and private banking products and services.

 

Treasury/Other: This segment includes revenue and expense related to assets, liabilities, and equity that are not directly assigned or allocated to one of the three business segments. Assets included in this segment include bank owned life insurance, investment securities, and mezzanine loans originated through Huntington Capital Markets Group.

 

A match-funded transfer pricing system is used to attribute appropriate interest income and interest expense to other business segments. The Treasury/Other segment includes the net impact of interest rate risk management, including derivative activities. Furthermore, this segment’s results include the investment securities portfolios and capital markets activities. Additionally, income or expense and provision for income taxes, not allocated to other business segments, are also included.

 

11


Table of Contents

Listed below is certain reported financial information reconciled to Huntington’s three and six month 2004 and 2003 operating results by line of business.

 

     Three Months Ended June 30,

 

Income Statements

(in thousands)


   Regional
Banking


    Dealer
Sales


    PFG

    Treasury/
Other


    Huntington
Consolidated


 

2004

                                        

Net interest income

   $ 155,083     $ 43,586     $ 11,166     $ 12,728     $ 222,563  

Provision for credit losses

     3,949       (8,261 )     (654 )     (61 )     (5,027 )

Non-Interest income

     82,475       85,983       27,680       21,990       218,128  

Non-Interest expense

     (147,840 )     (85,768 )     (28,559 )     (19,986 )     (282,153 )

Provision for income taxes

     (32,783 )     (12,439 )     (3,372 )     5,210       (43,384 )
    


 


 


 


 


Net income, as reported

     60,884       23,101       6,261       19,881       110,127  

Gain on sale of automobile loans, net of tax

     —         (2,068 )     —         (1,110 )     (3,178 )
    


 


 


 


 


Operating Earnings

   $ 60,884     $ 21,033     $ 6,261     $ 18,771     $ 106,949  
    


 


 


 


 


2003

                                        

Net interest income

   $ 150,418     $ 11,639     $ 9,785     $ 30,599     $ 202,441  

Provision for credit losses

     (40,525 )     (9,191 )     457       66       (49,193 )

Non-Interest income

     71,790       153,303       27,850       24,008       276,951  

Non-Interest expense

     (143,319 )     (125,464 )     (25,886 )     (2,364 )     (297,033 )

Provision for income taxes

     (13,427 )     (10,600 )     (4,272 )     (8,377 )     (36,676 )
    


 


 


 


 


Net income, as reported

     24,937       19,687       7,934       43,932       96,490  

Gain on sale of automobile loans, net of tax

     —         (2,216 )     —         (6,556 )     (8,772 )

Restructuring releases, net of taxes

     —         —         —         (3,455 )     (3,455 )
    


 


 


 


 


Operating Earnings

   $ 24,937     $ 17,471     $ 7,934     $ 33,921     $ 84,263  
    


 


 


 


 


     Six Months Ended June 30,

 

Income Statements

(in thousands)


   Regional
Banking


    Dealer
Sales


    PFG

    Treasury/
Other


    Huntington
Consolidated


 

2004

                                        

Net interest income

   $ 306,145     $ 73,891     $ 22,295     $ 42,917     $ 445,248  

Provision for credit losses

     1,844       (29,916 )     (97 )     (2,454 )     (30,623 )

Non-Interest income

     154,526       196,538       56,307       38,396       445,767  

Non-Interest expense

     (294,932 )     (177,137 )     (58,020 )     (37,718 )     (567,807 )

Provision for income taxes

     (58,654 )     (22,182 )     (7,170 )     9,721       (78,285 )
    


 


 


 


 


Net income, as reported

     108,929       41,194       13,315       50,862       214,300  

Gain on sale of automobile loans, net of tax

     —         (8,214 )     —         (817 )     (9,031 )
    


 


 


 


 


Operating Earnings

   $ 108,929     $ 32,980     $ 13,315     $ 50,045     $ 205,269  
    


 


 


 


 


2003

                                        

Net interest income

   $ 296,832     $ 27,286     $ 19,280     $ 60,802     $ 404,200  

Provision for credit losses

     (64,078 )     (20,576 )     (1,443 )     60       (86,037 )

Non-Interest income

     143,389       311,819       55,063       39,604       549,875  

Non-Interest expense

     (283,623 )     (259,633 )     (52,521 )     (16,735 )     (612,512 )

Provision for income taxes

     (32,382 )     (20,614 )     (7,133 )     (7,177 )     (67,306 )
    


 


 


 


 


Net income, as reported

     60,138       38,282       13,246       76,554       188,220  

Gain on sale of automobile loans, net of tax

     —         (4,807 )     —         (10,631 )     (15,438 )

Restructuring releases, net of taxes

     —         —         —         (4,105 )     (4,105 )
    


 


 


 


 


Operating Earnings

   $ 60,138     $ 33,475     $ 13,246     $ 61,818     $ 168,677  
    


 


 


 


 


 

12


Table of Contents
     Total Assets at

   Total Deposits at

Period-end Balance Sheet Data

(in millions)


   June 30,
2004


   December 31,
2003


   June 30,
2003


   June 30,
2004


   December 31,
2003


   June 30,
2003


Regional Banking

   $ 16,526    $ 14,971    $ 14,585    $ 16,435    $ 15,539    $ 16,628

Dealer Sales

     6,162      7,335      6,607      71      77      67

PFG

     1,540      1,461      1,328      1,016      1,164      1,027

Treasury / Other

     7,193      6,752      5,817      1,943      1,707      649
    

  

  

  

  

  

Total

   $ 31,421    $ 30,519    $ 28,337    $ 19,465    $ 18,487    $ 18,371
    

  

  

  

  

  

 

Note 9 – Comprehensive Income

 

The components of Huntington’s Other Comprehensive Income in the three and six months ended June 30 were as follows:

 

    

Three Months Ended

June 30,


   

Six Months Ended

June 30,


 

(in thousands)


   2004

    2003

    2004

    2003

 

Unrealized holding (losses) gains on securities available for sale arising during the period:

                                

Unrealized net (losses) gains

     (136,458 )     9,046       (74,755 )     1,799  

Related tax benefit (expense)

     47,760       (3,162 )     26,399       (935 )
    


 


 


 


Net

     (88,698 )     5,884       (48,356 )     864  
    


 


 


 


Less: Reclassification adjustment for net gains (losses) included in net income:

                                

Realized net gains (losses)

     9,230       (6,887 )     (5,860 )     (8,085 )

Related tax (expense) benefit

     (3,231 )     2,410       2,051       2,830  
    


 


 


 


Net

     5,999       (4,477 )     (3,809 )     (5,255 )
    


 


 


 


Total unrealized holding (losses) gains on securities available for sale arising during the period, net of reclassification adjustment for net gains included in net income.

                                
    


 


 


 


Net

     (82,699 )     1,407       (52,165 )     (4,391 )
    


 


 


 


Unrealized gains (losses) on derivatives used in cash flow hedging relationships arising during the period:

                                

Unrealized net gains (losses)

     52,315       (23,415 )     34,282       (26,295 )

Related tax (expense) benefit

     (18,310 )     8,195       (11,999 )     9,203  
    


 


 


 


Net

     34,005       (15,220 )     22,283       (17,092 )
    


 


 


 


Total Other Comprehensive Loss

   $ (48,694 )   $ (13,813 )   $ (29,882 )   $ (21,483 )
    


 


 


 


 

13


Table of Contents

Activity in Accumulated Other Comprehensive Income for the six months ended June 30, 2004 and 2003 was as follows:

 

(in thousands)


   Minimum
pension
liability


    Unrealized gains
(losses) on
securities
available for sale


    Unrealized gains
(losses) on derivative
instruments used in
cash flow hedging
relationships


    Total

 

Balance, December 31, 2002

   $ (195 )   $ 56,856     $ 5,639     $ 62,300  

Period change

     —         (4,391 )     (17,092 )     (21,483 )
    


 


 


 


Balance, June 30, 2003

   $ (195 )   $ 52,465     $ (11,453 )   $ 40,817  
    


 


 


 


Balance, December 31, 2003

   $ (1,309 )   $ 9,429     $ (5,442 )   $ 2,678  

Period change

     —         (52,165 )     22,283       (29,882 )
    


 


 


 


Balance, June 30, 2004

   $ (1,309 )   $ (42,736 )   $ 16,841     $ (27,204 )
    


 


 


 


 

Note 10 – Earnings per Share

 

Basic earnings per share is the amount of earnings for the period available to each share of common stock outstanding during the reporting period. Diluted earnings per share is the amount of earnings available to each share of common stock outstanding during the reporting period adjusted for the potential issuance of common shares upon the exercise of stock options. The calculation of basic and diluted earnings per share for each of the three and six months ended June 30 is as follows:

 

     Three Months Ended
June 30,


  

Six Months Ended

June 30,


(in thousands, except per share amount)


   2004

   2003

   2004

   2003

Net Income

   $ 110,127    $ 96,490    $ 214,300    $ 188,220
    

  

  

  

Average common shares outstanding

     229,429      228,633      229,328      229,987

Dilutive effect of common stock equivalents

     3,230      1,939      3,459      1,697
    

  

  

  

Diluted Average Common Shares Outstanding

   $ 232,659    $ 230,572    $ 232,787    $ 231,684
    

  

  

  

Earnings Per Share

                           

Basic

   $ 0.48    $ 0.42    $ 0.93    $ 0.82

Diluted

   $ 0.47    $ 0.42    $ 0.92    $ 0.81

 

The average market price of Huntington’s common stock for the period was used in determining the dilutive effect of outstanding stock options. Common stock equivalents are computed based on the number of shares subject to stock options that have an exercise price less than the average market price of Huntington’s common stock for the period.

 

Approximately 6.8 million and 5.1 million stock options were vested and outstanding at June 30, 2004 and 2003, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price was greater than the average market price of the common shares for the period and, therefore, the effect would be antidilutive. The weighted average exercise price for these options was $22.06 per share and $23.73 per share at the end of the same respective periods.

 

On July 30, 2004, Huntington entered into an agreement with the former shareholders of LeaseNet, Inc. to issue in early 2005 up to 86,118 shares of Huntington common stock previously held in escrow subject to LeaseNet meeting certain contractual performance criteria. A total of 366,576 common shares, previously held in escrow, will be returned to Huntington. All shares in escrow had been accounted for as treasury stock.

 

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Table of Contents

Note 11 – Stock-Based Compensation

 

Huntington’s stock-based compensation plans are accounted for based on the intrinsic value method promulgated by APB Opinion 25, Accounting for Stock Issued to Employees, and related interpretations. Compensation expense for employee stock options is generally not recognized if the exercise price of the option equals or exceeds the fair value of the stock on the date of grant.

 

The following pro forma disclosures for net income and earnings per diluted common share is presented as if Huntington had applied the fair value method of accounting of Statement No. 123 in measuring compensation costs for stock options. The fair values of the stock options granted were estimated using the Black-Scholes option-pricing model. This model assumes that the estimated fair value of the options is amortized over the options’ vesting periods and the compensation costs would be included in personnel expense on the income statement. The following table also includes the weighted-average assumptions that were used in the option-pricing model for options granted in each of the quarters presented:

 

    

Three Months Ended

June 30,


    Six Months Ended
June 30,


 
     2004

    2003

    2004

    2003

 

Stock Options Outstanding at period end (in thousands)

     19,252       17,399       19,252       17,399  

Assumptions

                                

Risk-free interest rate

     3.89 %     4.46 %     3.82 %     4.30 %

Expected dividend yield

     3.33 %     3.26 %     3.28 %     3.30 %

Expected volatility of Huntington’s common stock

     30.9 %     33.8 %     30.9 %     33.8 %

Pro Forma Results (in millions of dollars)

                                

Net income, as reported

   $ 110.1     $ 96.5     $ 214.3     $ 188.2  

Less pro forma expense, net of tax, related to options granted

     3.1       2.9       6.4       5.9  
    


 


 


 


Pro Forma Net Income

   $ 107.0     $ 93.6     $ 207.9     $ 182.3  
    


 


 


 


Net Income Per Common Share:

                                

Basic, as reported

   $ 0.48     $ 0.42     $ 0.93     $ 0.82  

Basic, pro forma

   $ 0.47     $ 0.41     $ 0.91     $ 0.79  

Diluted, as reported

   $ 0.47     $ 0.42     $ 0.92     $ 0.81  

Diluted, pro forma

   $ 0.46     $ 0.41     $ 0.89     $ 0.79  

 

Note 12 – Restructuring Reserves

 

On a quarterly basis, Huntington assesses its remaining restructuring reserves and makes adjustments to those reserves as necessary. Huntington had remaining reserves for restructuring of $8.3 million, $9.7 million, and $9.4 million as of June 30, 2004, December 31, 2003, and June 30, 2003, respectively. Huntington expects that the reserves will be adequate to fund the estimated future cash outlays.

 

Note 13 – Benefit Plans

 

Huntington sponsors the Huntington Bancshares Retirement Plan (the Plan), a non-contributory defined benefit pension plan covering substantially all employees. The Plan provides benefits based upon length of service and compensation levels. The funding policy of Huntington is to contribute an annual amount that is at least equal to the minimum funding requirements but not more than that deductible under the Internal Revenue Code. In addition, Huntington has an unfunded defined benefit post-retirement plan that provides certain healthcare and life insurance benefits to retired employees who have attained the age of 55 and have at least 10 years of vesting service under this plan. For any employee retiring on or after January 1, 1993, post-retirement healthcare benefits are based upon the employee’s number of months of service and are limited to the actual cost of coverage. Life insurance benefits are a percentage of the employee’s base salary at the time of retirement, with a maximum of $50,000 of coverage.

 

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The following table shows the components of net periodic benefit expense:

 

    

Pension Benefits

Three Months Ended

June 30,


    Post Retirement Benefits
Three Months Ended
June 30,


(in thousands)


   2004

    2003

    2004

   2003

Service cost

   $ 3,040     $ 2,454     $ 326    $ 280

Interest cost

     4,371       4,162       802      870

Expected return on plan assets

     (5,383 )     (6,285 )     —        —  

Amortization of transition asset

     —         (63 )     276      276

Amortization of prior service cost

     —         —         146      151

Settlements

     1,000       1,089       —        —  

Recognized net actuarial loss

     1,984       444       —        —  
    


 


 

  

Benefit Expense

   $ 5,012     $ 1,801     $ 1,550    $ 1,577
    


 


 

  

 

    

Pension Benefits

Six Months Ended

June 30,


    Post Retirement Benefits
Six Months Ended
June 30,


(in thousands)


   2004

    2003

    2004

   2003

Service cost

   $ 6,078     $ 4,909     $ 650    $ 561

Interest cost

     8,741       8,323       1,604      1,739

Expected return on plan assets

     (10,764 )     (12,568 )     —        —  

Amortization of transition asset

     —         (126 )     552      551

Amortization of prior service cost

     —         —         291      303

Settlements

     2,000       2,176       —        —  

Recognized net actuarial loss

     3,968       886       —        —  
    


 


 

  

Benefit Expense

   $ 10,023     $ 3,600     $ 3,097    $ 3,154
    


 


 

  

 

Huntington also sponsors other retirement plans. One of those plans is an unfunded Supplemental Executive Retirement Plan. This plan is a nonqualified plan that provides certain former officers of Huntington and its subsidiaries with defined pension benefits in excess of limits imposed by federal tax law. Other plans, including plans assumed in various past acquisitions, are unfunded, nonqualified plans that provide certain active and former officers of Huntington and its subsidiaries nominated by Huntington’s compensation committee with deferred compensation, post-employment, and/or defined pension benefits in excess of the qualified plan limits imposed by federal tax law.

 

Huntington has a 401(k) plan, which is a defined contribution plan that is available to eligible employees. Matching contributions by Huntington equal 100% on the first 3%, then 50% on the next 2%, of participant elective deferrals. The cost of providing this plan was $2.3 million and $2.1 million for the three months ended June 30, 2004 and 2003, respectively. For the respective six-month periods, the cost was $4.7 million and $4.3 million.

 

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Note 14 – Commitments and Contingent Liabilities

 

In the ordinary course of business, Huntington makes various commitments to extend credit that are not reflected in the financial statements. The contract amount of these financial agreements at June 30, 2004, December 31, 2003, and June 30, 2003, were as follows:

 

(in millions)


   June 30,
2004


   December 31,
2003


   June 30,
2003


Contract amount represents credit risk

                    

Commitments to extend credit

                    

Commercial

   $ 4,993    $ 5,712    $ 4,924

Consumer

     3,868      3,652      3,157

Commercial real estate

     586      952      891

Standby letters of credit

     962      983      978

Commercial letters of credit

     231      166      215

 

Commitments to extend credit:

 

Commitments to extend credit generally have fixed expiration dates, are variable-rate, and contain clauses that permit Huntington to terminate or otherwise renegotiate the contracts in the event of a significant deterioration in the customer’s credit quality. These arrangements normally require the payment of a fee by the customer, the pricing of which is based on prevailing market conditions, credit quality, probability of funding, and other relevant factors. Since many of these commitments are expected to expire without being drawn upon, the contract amounts are not necessarily indicative of future cash requirements. The interest rate risk arising from these financial instruments is insignificant as a result of their predominantly short-term, variable-rate nature.

 

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. The carrying amount of deferred revenue associated with these guarantees was $3.2 million, $3.8 million, and $3.3 million at June 30, 2004, December 31, 2003, and June 30, 2003, respectively.

 

Commercial letters of credit represent short-term, self-liquidating instruments that facilitate customer trade transactions and generally have maturities of no longer than 90 days. The merchandise or cargo being traded normally secures these instruments.

 

Litigation:

 

In the ordinary course of business, there are various legal proceedings pending against Huntington and its subsidiaries. In the opinion of management, the aggregate liabilities, if any, arising from such proceedings are not expected to have a material adverse effect on Huntington’s consolidated financial position. (See also Note 3.)

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

INTRODUCTION

 

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

 

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

 

Forward-Looking Statements

 

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

 

By their nature, forward-looking statements are subject to numerous assumptions, risks, and uncertainties. A number of factors could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to, those set forth below and under the heading “Business Risks” included in Item 1 of Huntington’s Annual Report on Form 10-K for the year ended December 31, 2003 (2003 Form 10-K), and other factors described in this report and from time to time in other filings with the Securities and Exchange Commission.

 

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

 

Risk Factors

 

Huntington, like other financial companies, is subject to a number of risks, many of which are outside of Management’s control, though Management strives 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 Huntington’s financial condition or results of operations, (3) liquidity risk, which is the risk that Huntington and / or the Bank will have insufficient cash or access to cash to meet operating needs, and (4) operational risk, which is the risk of loss resulting from inadequate or failed internal processes, people, or systems, or external events. The description of Huntington’s business contained in Item 1 of its 2003 Form 10-K, while not all inclusive, discusses a number of business risks that, in addition to the other information in this report, readers should carefully consider.

 

Securities and Exchange Commission Investigation

 

As previously disclosed, the Securities and Exchange Commission (SEC) is conducting a formal investigation regarding certain financial accounting and disclosure matters, including certain matters that were the subject of prior restatements by Huntington. The SEC staff has notified Huntington that the staff is considering recommending to the SEC that it institute enforcement action against Huntington and certain of its senior officers for, among other possible matters, violations of various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933 in connection with certain financial accounting matters relating to fiscal years 2002 and earlier, and certain related disclosure matters.

 

Huntington is presently in negotiations with the staff of the SEC regarding a settlement of its investigation. Huntington’s chief executive officer has indicated he accepts responsibility in his position as the chief executive officer for matters that occur on his watch, and has indicated a willingness to negotiate a settlement with the SEC of these matters. Huntington expects that a settlement of this matter would involve the entry of an order requiring, among other possible matters, Huntington to comply with various provisions of the Securities Exchange Act of 1934 and the Securities Act of 1933, along with the imposition of a fine and other possible measures. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.

 

Huntington also remains in active dialogue with its bank regulators concerning these matters and is working diligently with the regulators to resolve them in a manner that permits it to proceed with its pending Unizan acquisition. No assurances, however, can be provided as to the ultimate timing or outcome of these matters.

 

Donald R. Kimble, who joined Huntington earlier this year as executive vice president in the Finance area, has been named chief financial officer and controller. Prior to joining Huntington, Kimble was executive vice president and controller of AmSouth Bancorporation, and previously held various subsidiary chief financial officer or accounting positions at Bank One Corporation. Michael J. McMennamin and John D. Van Fleet have relinquished their positions of chief financial officer and controller, respectively. Both remain with the company.

 

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Table of Contents

Critical Accounting Policies and Use of Significant Estimates

 

Note 1 to the company’s Notes to Consolidated Financial Statements included in Huntington’s 2003 Form 10-K lists significant accounting policies used in the development and presentation of its financial statements. These significant accounting policies, as well as the following discussion and analysis and other financial statement disclosures, identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of Huntington, its financial position, results of operations, and cash flows.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires Huntington’s management to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in its financial statements. An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements of Huntington if a different amount within a range of estimates were used or if estimates changed from period to period. Readers of this interim report should understand that estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from when those estimates were made. Huntington’s management has identified the most significant accounting estimates and their related application in Huntington’s 2003 Form 10-K.

 

SUMMARY DISCUSSION OF RESULTS

 

Earnings comparisons from the second quarter of 2003 through the second quarter of 2004 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. Understanding the nature and implications of these factors on financial results is important in understanding the company’s income statement, balance sheet, and credit quality trends and the comparison of the current quarter and year-to-date performance with comparable prior-year periods. The key factors impacting the current reporting period comparisons are more fully described in the Significant Factors Influencing Financial Performance Comparisons section, which follows the summary of results below.

 

2004 Second Quarter versus 2003 Second Quarter

 

Huntington’s 2004 second quarter earnings were $110.1 million, or $0.47 per common share, up 14% and 12%, respectively, from $96.5 million and $0.42 per common share in the year-ago quarter. This increase in earnings reflected:

 

  90% decrease in provision for credit losses,

 

  10% increase in fully taxable equivalent net interest income, and

 

  5% decline in non-interest expenses

 

Partially offset by a 21% decline in non-interest income.

 

The return on average assets (ROA) and return on average equity (ROE), were 1.41% and 19.1%, respectively, compared with 1.38% and 18.0% in the year-ago quarter (see Table 1).

 

2004 Second Quarter versus 2004 First Quarter

 

Compared with 2004 first quarter net income of $104.2 million, or $0.45 per common share, 2004 second quarter earnings were up 6% and 4%, respectively. This increase in earnings primarily reflected:

 

  80% decline in provision for credit losses, and

 

  1% decline in non-interest expenses

 

Partially offset by a 4% decline in non-interest income.

 

The ROA and ROE were 1.41% and 19.1%, respectively, in the current quarter, compared with 1.36% and 18.4% in the 2004 first quarter (see Table 1).

 

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Table of Contents

Table 1 - Selected Quarterly Income Statement Data

 

(in thousands, except per share amounts)


   2004

    2003

    2Q04 vs. 2Q03

 
   Second

    First

    Fourth

    Third

    Second

    Amount

    %

 

Total interest income

   $ 324,167     $ 325,931     $ 335,097     $ 333,320     $ 317,325     $ 6,842     2.2 %

Total interest expense

     101,604       103,246       110,782       112,849       114,884       (13,280 )   (11.6 )%
    


 


 


 


 


 


 

Net interest income

     222,563       222,685       224,315       220,471       202,441       20,122     9.9 %

Provision for credit losses

     5,027       25,596       26,341       51,615       49,193       (44,166 )   (89.8 )%
    


 


 


 


 


 


 

Net interest income after provision for credit losses

     217,536       197,089       197,974       168,856       153,248       64,288     42.0 %
    


 


 


 


 


 


 

Operating lease income

     78,706       88,867       105,307       117,624       128,574       (49,868 )   (38.8 )%

Service charges on deposit accounts

     43,596       41,837       44,763       42,294       40,914       2,682     6.6 %

Trust services

     16,708       16,323       15,793       15,365       15,580       1,128     7.2 %

Brokerage and insurance

     13,523       15,197       14,344       13,807       14,196       (673 )   (4.7 )%

Mortgage banking

     23,322       (4,296 )     9,677       30,193       7,185       16,137     N.M.  

Bank owned life insurance

     11,309       10,485       10,410       10,438       11,043       266     2.4 %

Gain on sale of automobile loans

     4,890       9,004       16,288       —         13,496       (8,606 )   (63.8 )%

Gain on sale of branch office

     —         —         —         13,112       —         —       N.M.  

Other service charges and fees

     10,645       9,513       9,237       10,499       11,372       (727 )   (6.4 )%

Securities gains (losses)

     (9,230 )     15,090       1,280       (4,107 )     6,887       (16,117 )   N.M.  

Other

     24,659       25,619       19,411       23,543       27,704       (3,045 )   (11.0 )%
    


 


 


 


 


 


 

Total non-interest income

     218,128       227,639       246,510       272,768       276,951       (58,823 )   (21.2 )%
    


 


 


 


 


 


 

Personnel costs

     119,715       121,624       115,762       113,170       105,242       14,473     13.8 %

Operating lease expense

     62,563       70,710       85,609       93,134       102,939       (40,376 )   (39.2 )%

Outside data processing and other services

     17,563       18,462       15,957       17,478       16,104       1,459     9.1 %

Equipment

     16,228       16,086       16,840       16,328       16,341       (113 )   (0.7 )%

Net occupancy

     16,258       16,763       14,925       15,570       15,377       881     5.7 %

Professional services

     7,836       7,299       12,175       11,116       9,872       (2,036 )   (20.6 )%

Marketing

     8,069       7,839       6,895       5,515       8,454       (385 )   (4.6 )%

Telecommunications

     4,638       5,194       5,272       5,612       5,394       (756 )   (14.0 )%

Printing and supplies

     3,098       3,016       3,417       3,658       2,253       845     37.5 %

Amortization of intangibles

     204       204       204       204       204       —       N.M.  

Loss on early extinguishment of debt

     —         —         15,250       —         —         —       N.M.  

Restructuring reserve releases

     —         —         (351 )     —         (5,315 )     5,315     N.M.  

Other

     25,981       18,457       25,510       18,397       20,168       5,813     28.8 %
    


 


 


 


 


 


 

Total non-interest expense

     282,153       285,654       317,465       300,182       297,033       (14,880 )   (5.0 )%
    


 


 


 


 


 


 

Income before provision for income taxes

     153,511       139,074       127,019       141,442       133,166       20,345     15.3 %

Provision for income taxes

     43,384       34,901       33,758       37,230       36,676       6,708     18.3 %
    


 


 


 


 


 


 

Income before cumulative effect effect of change in accounting principle

     110,127       104,173       93,261       104,212       96,490       13,637     14.1 %

Cumulative effect of change in accounting principle, net of tax (1)

     —         —         —         (13,330 )     —         —       N.M.  
    


 


 


 


 


 


 

Net Income

   $ 110,127     $ 104,173     $ 93,261     $ 90,882     $ 96,490     $ 13,637     14.1 %
    


 


 


 


 


 


 

Per Common Share

                                                      

Income before cumulative effect of change in accounting

                                                      

principle - Diluted

   $ 0.47     $ 0.45     $ 0.40     $ 0.45     $ 0.42     $ 0.05     11.9 %

Net income - Diluted

     0.47       0.45       0.40       0.39       0.42       0.05     11.9 %

Cash dividends declared

     0.175       0.175       0.175       0.175       0.16       0.02     9.4 %

Return on:

                                                      

Average total assets (2)

     1.41 %     1.36 %     1.22 %     1.38 %     1.38 %     0.03 %   2.2 %

Average total shareholders’ equity (2)

     19.1 %     18.4 %     16.6 %     18.5 %     18.0 %     1.1 %   6.1 %

Net interest margin (3)

     3.29 %     3.36 %     3.42 %     3.46 %     3.47 %     (0.18 )%   (5.2 )%

Efficiency ratio (4)

     62.3 %     65.1 %     67.1 %     60.0 %     62.5 %     (0.2 )%   (0.3 )%

Effective tax rate

     28.3 %     25.1 %     26.6 %     26.3 %     27.5 %     0.8 %   2.9 %

Revenue - Fully Taxable Equivalent (FTE)

                                                      

Net interest income

   $ 222,563     $ 222,685     $ 224,315     $ 220,471     $ 202,441     $ 20,122     9.9 %

Tax equivalent adjustment (3)

     2,919       3,023       2,954       2,558       2,076       843     40.6 %
    


 


 


 


 


 


 

Net Interest Income

     225,482       225,708       227,269       223,029       204,517       20,965     10.3 %

Non-Interest Income

     218,128       227,639       246,510       272,768       276,951       (58,823 )   (21.2 )%
    


 


 


 


 


 


 

Total Revenue

   $ 443,610     $ 453,347     $ 473,779     $ 495,797     $ 481,468     $ (37,858 )   (7.9 )%
    


 


 


 


 


 


 


(1) Due to the adoption of FASB Interpretation No. 46 for variable interest entities.
(2) Based on income before cumulative effect change in accounting principle, net of tax.
(3) On a fully taxable equivalent (FTE) basis assuming a 35% tax rate.
(4) Non-interest expense less amortization of intangibles divided by the sum of FTE net interest income and non-interest income excluding securities gains (losses).
N.M. - Not Meaningful

 

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Table 2 - Selected Year to Date Income Statement Data

 

    

Six Months Ending

June 30,


    2004 vs. 2003

 

(in thousands, except per share amounts)


   2004

    2003

    Amount

    %

 

Total interest income

   $ 650,098     $ 637,339     $ 12,759     2.0 %

Total interest expense

     204,850       233,139       (28,289 )   (12.1 )%
    


 


 


 

Net interest income

     445,248       404,200       41,048     10.2 %

Provision for credit losses

     30,623       86,037       (55,414 )   (64.4 )%
    


 


 


 

Net interest income after provision for credit losses

     414,625       318,163       96,462     30.3 %
    


 


 


 

Operating lease income

     167,573       266,767       (99,194 )   (37.2 )%

Service charges on deposit accounts

     85,433       80,783       4,650     5.8 %

Trust services

     33,031       30,491       2,540     8.3 %

Brokerage and insurance

     28,720       29,693       (973 )   (3.3 )%

Mortgage banking

     19,026       18,310       716     3.9 %

Bank owned life insurance

     21,794       22,180       (386 )   (1.7 )%

Gain on sale of automobile loans

     13,894       23,751       (9,857 )   (41.5 )%

Other service charges and fees

     20,158       21,710       (1,552 )   (7.1 )%

Securities gains

     5,860       8,085       (2,225 )   (27.5 )%

Other

     50,278       48,105       2,173     4.5 %
    


 


 


 

Total non-interest income

     445,767       549,875       (104,108 )   (18.9 )%
    


 


 


 

Personnel costs

     241,339       218,331       23,008     10.5 %

Operating lease expense

     133,273       214,527       (81,254 )   (37.9 )%

Outside data processing and other services

     36,025       32,683       3,342     10.2 %

Equipment

     32,314       32,753       (439 )   (1.3 )%

Net occupancy

     33,021       31,986       1,035     3.2 %

Professional services

     15,135       19,157       (4,022 )   (21.0 )%

Marketing

     15,908       15,080       828     5.5 %

Telecommunications

     9,832       11,095       (1,263 )   (11.4 )%

Printing and supplies

     6,114       5,934       180     3.0 %

Amortization of intangibles

     408       408       —       N.M.  

Restructuring reserve releases

     —         (6,315 )     6,315     N.M.  

Other

     44,438       36,873       7,565     20.5 %
    


 


 


 

Total non-interest expense

     567,807       612,512       (44,705 )   (7.3 )%
    


 


 


 

Income before provision for income taxes

     292,585       255,526       37,059     14.5 %

Provision for income taxes

     78,285       67,306       10,979     16.3 %
    


 


 


 

Net Income

   $ 214,300     $ 188,220     $ 26,080     13.9 %
    


 


 


 

Per Common Share

                              

Net income - Diluted

   $ 0.92     $ 0.81     $ 0.11     13.6 %

Cash dividends declared

   $ 0.35     $ 0.32     $ 0.03     9.4 %

Return on:

                              

Average total assets

     1.36 %     1.35 %     0.01 %   0.8 %

Average total shareholders’ equity

     18.4 %     17.3 %     1.1 %   6.1 %

Net interest margin (1)

     3.32 %     3.52 %     (0.20 )%   (5.7 )%

Efficiency ratio (2)

     63.7 %     64.4 %     (0.7 )%   (1.1 )%

Effective tax rate

     26.8 %     26.3 %     0.5 %   1.7 %

Revenue - Fully Taxable Equivalent (FTE)

                              

Net interest income

   $ 445,248     $ 404,200     $ 41,048     10.2 %

Tax equivalent adjustment (1)

     5,942       4,172       1,770     42.4 %
    


 


 


 

Net Interest Income

     451,190       408,372       42,818     10.5 %

Non-Interest Income

     445,767       549,875       (104,108 )   (18.9 )%
    


 


 


 

Total Revenue

   $ 896,957     $ 958,247     $ (61,290 )   (6.4 )%
    


 


 


 


(1) On a fully taxable equivalent (FTE) basis assuming a 35% tax rate.
(2) Non-interest expense less amortization of intangibles divided by the sum of FTE net interest income and non-interest income excluding securities gains.

 

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2004 First Six Months versus 2003 First Six Months

 

Earnings for the first six months of 2004 were $214.3 million, or $0.92 per common share, both up 14% from the comparable year-ago period earnings of $188.2 million, or $0.81 per common share. This increase in earnings reflected:

 

  64% decrease in provision for credit losses,

 

  10% increase in fully taxable equivalent net interest income, and

 

  7% decline in non-interest expenses

 

Partially offset by a 19% decline in non-interest income.

 

The ROA and ROE were 1.36% and 18.4%, respectively, compared with 1.35% and 17.3% in the year-ago six-month period (see Table 2).

 

Significant Factors Influencing Financial Performance Comparisons

 

Earnings comparisons from the second quarter of 2003 through the second quarter of 2004 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. Automobile leases originated through April 2002 accounted for as operating leases – Automobile leases originated before May 2002 are accounted for using the operating lease method of accounting because they do not qualify as direct financing leases. Operating leases are a non-interest earning asset with the related rental income, other revenue, and credit recoveries reflected as operating lease income, a component of non-interest income. Under this accounting method, depreciation expenses, as well as other costs and charge-offs, are reflected as operating lease expense, a component of non-interest expense. With no new operating leases originated since April 2002, the operating lease assets are rapidly decreasing and will eventually run-off, along with related operating lease income and expense. Since operating lease income and expense represent a significant percentage of total non-interest income and expense, respectively, throughout this reporting period, their downward trend influences total non-interest income and non-interest expense trends.

 

       All 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 provision for credit losses. The relative newness and rapid growth of this portfolio has resulted in higher reported automobile lease growth rates than in a more mature portfolio. To better understand overall trends in automobile lease exposure it is helpful to compare trends of the combined total of automobile leases plus operating leases (see the company’s 2003 Form 10-K for a full discussion).

 

  2. Transition from a weak economic environment in 2003 to a recovering economic environment in 2004. The weak economic environment resulted in significant reductions in non-performing assets (NPAs), charge-offs, and the ALLL, as well as continued weak demand for commercial and industrial (C&I) loans, which contributed to declining C&I loans through the first quarter of 2004.

 

  3. Declining interest rates in 2003 with generally increasing interest rates in 2004. Interest rates impacted, among other factors, loan and deposit growth, the net interest margin, and the valuation of mortgage servicing rights (MSRs) and investment securities.

 

  The historically low interest rate environment resulted in strong demand and resultant growth in residential real estate, home equity, and commercial real estate (CRE) loans generally throughout this period. Mortgage banking revenue was also favorably impacted by the significant mortgage origination activity.

 

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  As interest rates fell in 2003 and attained historically low absolute levels, it became increasingly difficult to lower interest rates offered on deposit accounts commensurate with the overall decline in interest rates and yields on earning assets. This created an extremely competitive environment in which to grow deposits. These factors resulted in an inability to lower deposit rates commensurate with the overall decline in earning asset rates, which contributed to the decline in the net interest margin throughout this period.

 

  Since the second quarter of 2002, the company generally has retained the servicing on mortgage loans it originates and sells. The mortgage servicing right, or MSR, represents the present value of expected future net servicing income for the loan. MSR values are very sensitive to movements in interest rates. Expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly affected by prepayments. Prepayments usually increase when interest rates decline and decrease when interest rates rise. Thus, as interest rates decline, less future income is expected and the value of MSRs declines and becomes impaired when the valuation is less than the recorded book value. The company recognizes temporary impairment due to change in interest rates through a valuation reserve and records a direct write-down of the book value of its MSRs for other-than-temporary declines in valuation. Changes in interest rate levels between quarters resulted in some quarters reporting an MSR temporary impairment, with others reporting a recovery of previously reported MSR temporary impairment. Such swings in MSR valuations have significantly impacted quarterly mortgage banking income throughout this period (see Table 3).

 

  The company uses gains or losses on investment securities to offset MSR temporary valuation changes. As a result, changes in interest rate levels have also resulted in securities gains or losses. As such, in quarters where an MSR temporary impairment is recognized, investment securities were sold resulting in a gain on sale, and vice versa. The earnings impact of the MSR valuation change and securities gain/loss may not exactly offset due to, among other factors, the difference in the timing of when the MSR valuation is determined and recorded, compared with when the securities are sold and any gain or loss is recorded (see Table 3).

 

  4. Management strategies to lower the overall credit risk profile of the balance sheet. Throughout this period, certain strategies were implemented to lower the overall credit risk profile of the balance sheet with the objective of lowering the volatility of earnings.

 

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

 

  Reduction in large-individual C&I and CRE credits – This strategy has been reflected in the reduction in shared national credits, as well as other, mostly C&I, loans. In addition, the company sold and charged-off lower-quality C&I and CRE credits in 2003 and 2004. This strategy was a contributing factor in the declines in C&I loan balances, NPAs, and the ALLL. In certain quarters, this strategy contributed to higher C&I net charge-offs.

 

  5. Adoption of FIN 46 – Effective July 1, 2003, the company adopted Financial Accounting Standards Board (FASB) Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities. The adoption of FIN 46 resulted in the consolidation of $1.0 billion of previously securitized automobile loans and a $13.3 million after-tax charge in the 2003 third quarter for the cumulative effect of a change in accounting principle (see Tables 1 and 2).

 

  6. Corporate Restructuring Charges – The 2001 strategic refocusing plan included the intent to sell the Florida banking and insurance operations, credit-related and other actions to strengthen the balance sheet and financial performance, and the consolidation of numerous non-Florida banking offices. As a result, non-interest expenses in 2001 and 2002 were higher than they otherwise would have been as they included net restructuring charges based on estimated costs associated with implementing these strategic initiatives. In contrast, 2003 non-interest expense reflected recoveries of previously established reserves, which were no longer needed (see Table 3) and lowered 2003 non-interest expense (see Note 21 of the company’s 2003 Form 10-K Notes to Consolidated Financial Statements). There were no increases or releases of restructuring charges in the first half of 2004.

 

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  7. Single commercial recovery – A single commercial credit recovery in the 2004 second quarter on a loan previously charged off in the 2002 fourth quarter favorably impacted the 2004 second quarter provision expense (see Table 3), as well as C&I, total commercial, and total net charge-offs for the quarter (see Table 11).

 

The following table quantifies the earnings impact of changes in MSR and investment securities valuation, sales of automobile loans, restructuring reserve releases, and a single, large commercial credit recovery on the specified periods.

 

Table 3 - Significant Items Influencing Earnings Performance Comparisons

 

(in millions, except per share )


  

Pre-tax


   

Impact

After-tax (1)


   

EPS


 
      

Three Months Ended:

                        

June 30, 2004 - GAAP earnings

   $ 153.5     $ 110.1     $ 0.47  

Gain on sale of automobile loans

     4.9       3.2       0.01  

Mortgage servicing right (MSR) temporary impairment recovery

     10.4       6.8       0.03  

Investment securities losses

     (9.2 )     (6.0 )     (0.03 )

Single commercial credit recovery

     9.7       6.3       0.03  

June 30, 2003 - GAAP earnings

   $ 133.2     $ 96.5     $ 0.42  

Gain on sale of automobile loans

     13.5       8.8       0.04  

MSR temporary impairment

     (6.4 )     (4.1 )     (0.02 )

Investment securities gains

     6.9       4.5       0.02  

Restructuring reserve releases

     5.3       3.5       0.01  

Six Months Ended:

                        

June 30, 2004 - GAAP earnings

   $ 292.6     $ 214.3     $ 0.92  

Gain on sale of automobile loans

     13.9       9.0       0.04  

MSR temporary impairment recovery

     0.3       0.2       —    

Investment securities gain on sale

     5.9       4.0       0.02  

Single commercial credit recovery

     9.7       6.3       0.03  

June 30, 2003 - GAAP earnings

   $ 255.5     $ 188.2     $ 0.81  

Gain on sale of automobile loans

     23.8       15.0       0.06  

MSR temporary impairment

     (6.4 )     (4.1 )     (0.02 )

Investment securities gains

     8.1       5.0       0.02  

Restructuring reserve releases

     6.3       4.0       0.02  

(1) Increase (decrease) to GAAP earnings.

 

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RESULTS OF OPERATIONS

 

Net Interest Income

 

2004 Second Quarter versus 2003 Second Quarter

 

Fully taxable equivalent net interest income increased $21.0 million, or 10%, from the year-ago quarter, reflecting the favorable impact of a 16% increase in average earning assets, partially offset by an 18 basis point, or an effective 5%, decline in the net interest margin. The fully taxable equivalent net interest margin decreased to 3.29% from 3.47%, reflecting the continued impact of historically low interest rates and the strategic repositioning of portfolios to reduce automobile loans and increase the relative proportion of lower-rate, and lower-risk, residential real estate-related loans and investment securities.

 

Average total loans and leases increased $2.5 billion, or 13%, from the 2003 second quarter due primarily to a $2.2 billion, or 23%, increase in average consumer loans. Contributing to the consumer loan growth was a $1.1 billion, or 58%, increase in average residential mortgages and a $0.8 billion, or 23%, increase in average home equity loans. Average total automobile loans and leases increased $0.3 billion, or 8%. This growth from the year-ago quarter reflected the positive impact of underlying new automobile loan originations, the 2003 third quarter consolidation of a $1.0 billion automobile loan securitization trust, and the rapid growth in direct financing leases due to the migration from operating lease assets, which are no longer being originated. Offsetting these positive impacts was the sale of $2.4 billion of automobile loans over this 12-month period (see Loan and Lease Composition for additional discussion and Table 10).

 

Average total C&I and CRE loans increased $0.3 billion, or 3%, from the year-ago quarter, reflecting an 11% increase in small business C&I and CRE loans and a 9% increase in middle-market CRE loans. Average middle-market C&I loans were down 4% from the year-ago period and reflected both weak demand and the impact from continued strategies to specifically lower exposure to large individual commercial credits, including shared national credits.

 

Average investment securities increased $1.6 billion, or 43%, from the year-ago quarter, primarily reflecting the investment of a portion of the proceeds from the automobile loan sales. The growth from the year-ago quarter primarily consisted of 10-year variable-rate securities.

 

Average total core deposits in the second quarter were $16.2 billion, up $0.8 billion, or 5%, from the year-ago quarter. This growth primarily reflected a $1.1 billion, or 18%, increase in interest bearing demand deposits, partially offset by a $0.4 billion, or 14%, decline in retail CDs.

 

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Tables 4 and 5 reflect quarterly average balance sheets and rates earned and paid on interest-earning assets and interest-bearing liabilities:

 

Table 4 - Condensed Consolidated Quarterly Average Balance Sheets

 

     Average Balances

   2Q04 vs. 2Q03

 

(in millions)


   2004

   2003

  

Fully Tax Equivalent Basis


   Second

   First

   Fourth

   Third

   Second

   Amount

    Percent

 

Assets

                                                 

Interest bearing deposits in banks

   $ 69    $ 79    $ 83    $ 90    $ 45    $ 24     53.3 %

Trading account securities

     28      16      11      11      22      6     27.3  

Federal funds sold and securities purchased under resale agreements

     168      92      117      103      69      99     N.M.  

Loans held for sale

     254      207      295      898      601      (347 )   (57.7 )

Securities:

                                                 

Taxable

     4,861      4,646      4,093      3,646      3,385      1,476     43.6  

Tax exempt

     410      437      424      358      291      119     40.9  
    

  

  

  

  

  


 

Total Securities

     5,271      5,083      4,517      4,004      3,676      1,595     43.4  
    

  

  

  

  

  


 

Loans and Leases:

                                                 

Commercial and industrial

     5,536      5,365      5,382      5,380      5,626      (90 )   (1.6 )

Real Estate

                                                 

Construction

     1,322      1,322      1,297      1,258      1,239      83     6.7  

Commercial

     2,906      2,876      2,830      2,744      2,621      285     10.9  

Consumer

                                                 

Automobile loans

     2,337      3,041      3,529      3,594      2,830      (493 )   (17.4 )

Automobile leases

     2,139      1,988      1,802      1,590      1,306      833     63.8  
    

  

  

  

  

  


 

Automobile loans and leases

     4,476      5,029      5,331      5,184      4,136      340     8.2  
    

  

  

  

  

  


 

Home equity

     4,142      3,880      3,678      3,503      3,359      783     23.3  

Residential mortgage

     2,986      2,674      2,501      2,075      1,887      1,099     58.2  

Other loans

     399      356      387      367      379      20     5.3  
    

  

  

  

  

  


 

Total Consumer

     12,003      11,939      11,897      11,129      9,761      2,242     23.0  
    

  

  

  

  

  


 

Total Loans and Leases

     21,767      21,502      21,406      20,511      19,247      2,520     13.1  
    

  

  

  

  

  


 

Allowance for loan and lease losses

     310      313      350      330      304      6     2.0  
    

  

  

  

  

  


 

Net loans and leases

     21,457      21,189      21,056      20,181      18,943      2,514     13.3  
    

  

  

  

  

  


 

Total earning assets

     27,557      26,979      26,429      25,617      23,660      3,897     16.5  
    

  

  

  

  

  


 

Operating lease assets

     977      1,166      1,355      1,565      1,802      (825 )   (45.8 )

Cash and due from banks

     772      740      766      747      735      37     5.0  

Intangible assets

     216      217      217      218      218      (2 )   (0.9 )

All other assets

     2,101      2,046      2,005      2,067      1,988      113     5.7  
    

  

  

  

  

  


 

Total Assets

   $ 31,313    $ 30,835    $ 30,422    $ 29,884    $ 28,099    $ 3,214     11.4 %
    

  

  

  

  

  


 

Liabilities and Shareholders’ Equity

                                                 

Core deposits

                                                 

Non-interest bearing deposits

   $ 3,223    $ 3,017    $ 3,131    $ 3,218    $ 3,046    $ 177     5.8 %

Interest bearing demand deposits

     7,168      6,609      6,466      6,558      6,100      1,068     17.5  

Savings deposits

     2,839      2,819      2,824      2,808      2,804      35     1.2  

Retail certificates of deposit

     2,400      2,399      2,492      2,561      2,798      (398 )   (14.2 )

Other domestic time deposits

     600      637      631      656      673      (73 )   (10.8 )
    

  

  

  

  

  


 

Total core deposits

     16,230      15,481      15,544      15,801      15,421      809     5.2  
    

  

  

  

  

  


 

Domestic time deposits of $100,000 or more

     795      788      828      803      808      (13 )   (1.6 )

Brokered time deposits and negotiable CDs

     1,737      1,907      1,851      1,421      1,241      496     40.0  

Foreign time deposits

     542      549      522      536      426      116     27.2  
    

  

  

  

  

  


 

Total deposits

     19,304      18,725      18,745      18,561      17,896      1,408     7.9  
    

  

  

  

  

  


 

Short-term borrowings

     1,396      1,603      1,433      1,393      1,635      (239 )   (14.6 )

Federal Home Loan Bank advances

     1,270      1,273      1,273      1,273      1,267      3     0.2  

Subordinated notes and other long-term debt,

                                                 

including preferred capital securities

     5,623      5,557      5,432      5,197      4,010      1,613     40.2  
    

  

  

  

  

  


 

Total interest bearing liabilities

     24,370      24,141      23,752      23,206      21,762      2,608     12.0  
    

  

  

  

  

  


 

All other liabilities

     1,397      1,399      1,311      1,221      1,140      257     22.5  

Shareholders’ equity

     2,323      2,278      2,228      2,239      2,151      172     8.0  
    

  

  

  

  

  


 

Total Liabilities and Shareholders’ Equity