Huntington Bancshares Inc (HBAN) 2004 Q2 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Huntington Good day, ladies and gentlemen, and welcome to the Huntington Good day, ladies and gentlemen, and welcome to the Huntington Bancshares second quarter 2004 earnings conference call. second quarter 2004 earnings conference call. ladies and gentlemen, and welcome to the Huntington Bancshares second quarter 2004 earnings conference call. second quarter 2004 earnings conference call.

At this time all participants are in a listen-only mode.

Later we will conduct a question-and-answer session, and instructions will follow at that time.

If anyone should require assistance during the conference, please press the star then 0 keys on your touch-tone telephone.

If anyone should disconnect and need to rejoin please dial 1-866-206-5917.

And as a reminder, ladies and gentlemen, this conference is being recorded.

I would now like to introduce your host for today's conference, Mr. Jay Gould, Senior Vice President of Investor Relations.

Mr. Gould, you may begin.

[Audio begins here]-- through the end of this month.

Please call the Investor Relations Department at 614-480-5676 for more information on how to access these recordings or playback or should you have difficulty getting copies of the slides.

Today's discussion including the Q and A period may contain forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995.

Such statements are based on information and assumptions available at this time and are subject to change and risks and uncertainties which may cause actual results to differ materially.

We assume no obligation to update such statements.

For complete discussion of risks and uncertainties please refer to the slide at the end of today's presentation as well as material filed with the SEC including our most recent Form 10-K and 8-K filings.

Let's begin.

Presenting today are Tom Hoaglin, Chairman, President, and Chief Executive Officer and Mike McMennamin, Vice Chairman Chief Financial Officer.

Also present for the Q&A period is Tim Barber, Senior Vice President of Credit Risk Management.

Slide 3 notes several aspects of the basis of today's presentation.

I encourage you to read this but let me point out a couple of key disclosures related to the basis of the presentation.

First this presentation contains GAAP financial measures and non-GAAP financial measures where we believe it helpful to understanding Huntington's results of operations or financial position.

Where Non-GAAP financial measures are used, the comparable GAAP financial measure as well as the reconciliation to the comparable GAAP financial measure can be found in the slide presentation, in the its appendix or the quarterly financial review supplement to today's earnings press release.

And these can be found on our website.

Also, certain performance data we will review are shown on an annualized basis and in the discussion of net interest income we do this on a fully taxable equivalent basis.

Further, we relate certain 1 time revenue and expense items on an after-tax per-share basis.

Many of you I know are familiar with these terms and their usage but for those who are not we provide a definitions and rationale for their usage on slide 3.

Today's presentation is going to take about 25 minutes.

And like always we want to get to your questions, so let's get started.

Tom.

Thank you, Jay, and welcome everyone.

Thanks again for joining us.

Turning to slide 4 I'll begin with review of significant second quarter events and highlights.

Mike will then follow with the usual in depth review of the quarter's financial performance.

And I'll wrap up with a session -- wrap up the session with an update on our outlook for 2004 performance.

Slide 5 reviews recent key events and highlights of the quarter.

We were pleased to announce 2 days ago a 14.3% increase in our common stock dividend of 20 cents per common share up from 17.5 cents per share.

This dividend will be payable October 1st to shareholders of record September 17th.

This restores the dividend to the level it was prior to our having to reduce it by 20% in July of 2001.

It's been long roundtrip for many of our shareholders since we reduced the dividend.

And we've appreciated their support and patience throughout this period.

Our ability to increase the dividend testifies to the progress we've made over the last 3 years in moving Huntington forward.

Next I know some of you are on the call today to find out where we stand with the merger with Unizan.

As you know we were targeting to close the merger in early July.

As we announced on June 16th the Federal Reserve Board informed us it was extending its review period to coordinate further with the staff of the Securities and Exchange Commission regarding the SEC's ongoing formal investigation of Huntington.

And to complete its review of the Community Reinvestment A act aspects of the merger.

Huntington and Unizan integration groups are on target to complete all of their necessary preparation work.

So we stand ready to close the merger subject to receipt of the necessary regulatory approvals.

Turning now to the discussion of second quarter financial performance.

Earnings were 47 cents per common share up from 45 cents per common share in the first quarter and 12% higher than 42 cents per share a year ago.

The primary driver of this performance was a significant improvement in credit quality on a number of fronts that resulted in a decrease in the loan loss reserve and lower provision expense.

Specifically, net charge-offs came in at only 23 basis points which included an 18 basis point benefit of 1 large commercial recovery.

Excluding the impact of this recovery, net charge-offs were 41 basis points.

In addition, we experienced a $17 million, or 19%, decline in nonperforming assets aided by the sale of some nonperforming assets.

At quarter end, our nonperforming asset ratio was only 34 basis points, down from 43 basis points at the end of March.

Reflecting these factors, and other factors like the improvement in the economic outlook, the loan loss reserve ratio declined to 1.32%.

Our reserve position at quarter end was very strong, and represented 384% coverage of NPAs, up from 322% at the end of last quarter.

During the quarter, we also continued to make progress in reducing our auto loan and lease exposure.

On June 30th we sold $512 million of auto loans and transferred another $102 million to held for sale.

We've sold 3.6 billion of auto loans since the beginning of last year.

This has reduced our auto loan and lease exposure from a high of 33% of total credit exposure at the end 2002 to 22% at the end of the second quarter, approaching our 20% target.

A hallmark of Huntington's performance over the last 3 years has been strong loan growth.

This was again true this quarter.

Loans grew an annualized 19% excluding the impact of the auto loan sales.

Led again by strong residential mortgage and home equity loan growth.

We're also encouraged that our middle market C&I loans grew at a 10% annualized rate, the first growth in many quarters.

Small business loans posted another good quarter as did commercial real-estate loans.

Deposits grew at a strong 19% annualized rate with particular strength in demand and interest-bearing demand deposits.

CDs were flat, reversing the downward trend of the last several quarters.

This reflected our focused sales efforts and increased effectiveness at growing deposits, especially with existing customers.

As you know, one of our objectives had been to reduce the overall risk profile of our earning assets.

Mostly through the origination of low-risk residential and home equity loans, as well as the sale of auto loans.

This mix shift has contributed in the decline and the net interest margin.

However, we're comfortable with the risk-adjusted margins on these products given their lower expected net charge-offs.

Our net interest margin declined to 3.29% from 3.36% in the first quarter.

In sum, credit quality performance was very good, and period end reserves and capital were at strong levels.

Once again loan growth was strong and included C&I growth for the first time in many quarters and deposit growth was very strong.

It was a very good quarter, and Huntington is well positioned for continued progress.

Let me now turn the presentation over to Mike who will provide some additional details.

Mike.

Thanks, Tom.

As shown on slide 7 reported or GAAP net income was 110.1 million or 47 cents per share.

There were 4 significant items impacting the quarter's results.

First, 4.9 million of pretax gains, roughly a penny a share, on the sale of auto loans.

Second, a 10.4 million pretax, or 3 cents per share, recovery of previously recorded MSR, mortgage servicing rights, temporary impairment.

This follows $10.1 million pretax, or 3 cents a share, of MSR temporary impairment in the first quarter.

Recall interest rates declined in the first quarter and then did an about-face and increased during the second quarter.

Third, there were a total investment security losses of $9.2 million pretax, or 3 cents per share.

Losses on securities used to offset MSR valuation changes totaled $10.2 million.

You'll recall we used investment securities gains and losses to offset MSR temporary valuation changes.

Fourth, was a single $9.7 million commercial loan recovery which equated to about 3 cents a share.

The remaining slides are the ones we typically use to review our financial performance, and there are additional slides in the appendix to give you more detailed information.

Slide 8 is our typical highlights page.

Let me just comment on a couple of issues.

First you'll recall that last quarter we separated the allowance for unfunded loan commitments into a liability account distinct from our total allowance for loan and lease losses.

It's important to remember that both allowances are available to cover credit losses.

Near the bottom of the slide we show the loan loss reserve ratio excluding the reserve for unfunded loan commitments was 1.32% at June 30 but was 1.46% when the reserve for unfunded loan commitments was included.

Second, as been the upward trend in the tangible common equity risk-weighted assets as shown on the bottom of the slide.

The quarter-end ratio was 7.64% up significantly from a year ago.

This improvement represents one way of quantifying the lower risk nature of our balance sheet compared with a year ago.

I'll be talking about most of these items in detail later, so let's move on to the next slide.

Slide 9 compares the income statement for the second quarter, the first quarter, and the year-ago quarter.

Compared with the first quarter, net interest income was essentially flat, showing the benefits of growing loans and other earning assets but the net interest margin declined.

Most notable is the significant decline in the provision for credit losses, which totaled $5 million in the second quarter.

I'll discuss our reserve methodology in detail later.

The point that should be emphasized is that our new methodology is more quantitatively driven.

And that our loan loss reserves are strong even though the loan loss reserve ratio declined.

The declines in noninterest income and noninterest expense continue to be impacted by the runoff in operating lease.

More on that later.

The graphs on slide 10 simply show the quarterly trend in net income and earnings per share.

Reported second quarter net income and earnings per common share increased 14% and 12% respectively from the year-ago quarter.

Slide 11 shows that second quarter net interest income on a fully taxable equivalent basis increased 10% from the year-ago quarter.

So it has been basically flat on a dollar basis for the last 4 quarters, despite a declining net interest margin.

The right-hand side of this chart shows some of the factors that have been influencing the net interest margin performance in recent quarters.

First, our net interest margins declined for many of the same reasons margins have declined and are still declining in the banking industry.

That is, prepayments of fixed rate mortgages and other consumer loans as well as difficulty in reducing deposit rates as rapidly as market rates have declined.

Equally important impact but 1 perhaps more unique to Huntington has been the significant shift in the composition of our balance sheet towards less risky but lower yielding assets both in the form of loans and securities.

The lower risk, lower yield residential real estate and home equity loans are a higher percentage of earning assets with auto loans a smaller percentage.

In addition, there's been growth in lower margin investment securities over the last year which is related entirely to investment of a portion but not the entirety, of the proceeds from auto loan sales.

For example, if you look at our investment securities portfolio at June 30th we were down 467 million, or 9%, from the portfolio total at March 31st.

And we anticipate further reductions over the second half of the year.

Second, lower deposit costs continue to benefit the net interest margin.

During the second quarter the average rate on total core deposits was 1.45%, down 8 basis points from 153 in the first quarter.

Lastly as a reminder that the runoff in our operating lease portfolio has a positive impact on our margin.

Over time as new leases are recorded as direct financing leases, operating lease fee income declines and direct financing lease interest income increases, along with the net interest margin.

Slide 12 illustrates a change in the loan portfolio mix over the last 6 quarters to the lower margin, lower risk credits.

We've talked about our auto loan exposure from 33% at the end of 2002 to 22% at the end of June as shown on the bottom of this slide.

Offsetting the relative decline in auto loans in the total portfolio has been a corresponding relative increase in lower risk residential real estate and home equity loans.

Combined, these 2 portfolios have increased from 23% to 33% of the total loan portfolio.

These changes in our portfolio composition bode well for future loan charge-offs and will over time also reduce overall loan loss reserves.

Average loan and lease growth is highlighted on slide 13.

This shows that total average loans and leases increased an annualized 5% during the quarter.

But as is footnoted here the underlying annualized growth rate was a very strong 19% after giving consideration to the impact of the auto loan sales.

We noted in last quarter's conference call that late in the first quarter we began to see some indications of middle market C&I loan growth.

This carried over in the second quarter as these loans increased at a 10% annualized rate.

Middle market commercial real-estate loans increased at a 6% annualized rate somewhat slower than recently quarterly growth rates.

Small business C&I and commercial real-estate loans together made through our retail delivery channels grew at an encouraging 9% annualized rate and 11% versus a year ago.

We continue to be very pleased with the progress in growing this business.

Auto loans declined significantly reflecting the impact of the $868 million auto loan sale late in the first quarter.

This second quarter auto loan sale of 512 million and the transfer of $102 million of loans to held for sale occurred on June 30th and had no meaningful impact on average balance sheet trends in the second quarter.

Excluding the first quarter auto loan sale impact on second quarter average loans, the underlying auto loan growth rate would have been a positive 7%.

Auto direct financing leases averaged $2.1 billion in the second quarter, a 30% annualized growth rate.

Operating lease assets which are classified as non earning assets and are listed near the bottom of this table continue to run off an average $1 billion in the current quarter.

Those of you familiar with Huntington's story know that all auto leases originated since April of 2002 have been booked as direct financing leases.

When the direct financing lease and operating lease portfolios are combined, the total lease portfolio has been essentially flat.

I refer to you slides 51 through 53 in the appendix for additional auto loan and lease trend information.

Home equity loans and lines and residential mortgages, primarily adjustable rate mortgages, continued their strong growth up 27% and 47% respectively on an annualized basis from the first quarter.

Slide 14 provides a reconciliation of the impact of the auto loan sales on second quarter growth rates for auto loans as well as total loans and leases which, when adjusted, had annualized growth rates of 7% and 19% respectively.

Slide 15 shows that total core deposits excluding CDs increased an annualized 23% from the first quarter and were up 10% from the year-ago quarter.

We're encouraged with the strong growth in demand and interest-bearing demand accounts up 27% and 34% on an annualized basis from the first quarter.

With interest rates rising, CDs are becoming increasingly more attractive to depositors.

And while the level of our retail CDs was flat with the first quarter level this reversed trend of net quarterly declines over the last year or 2.

As a result, total average core deposits, including CDs, increased at a 19% annualized rate during the quarter.

Slide 16 reviews trends in noninterest income.

As a result of operating lease accounting, operating lease income accounted for 36% of noninterest income.

Total noninterest income declined $9.5 million, or 4% from the first quarter.

Excluding the decline in operating lease income, total noninterest income was up $700,000 from the first quarter.

The main drivers of this increase were a $27.6 million increase in mortgage banking income as the current quarter included $10.4 million recovery of previously recognized MSR temporary impairment compared with 10.1 million MSR temporary impairment in the first quarter.

In addition, gains on sales of loans in the secondary market and loan origination fees were higher in the second quarter.

Also $1.8 million or 4% increase in deposit service charges which are 7% higher than a year ago.

This primarily reflects higher NSF and overdraft fees.

A $1.1 million, or 12% increase in other service charges due to higher electronic banking and interchange fees.

These increases were partially offset by a 24.3 million reduction in net security gains as the current quarter included 9.2 million of security losses compared with 15.1 million of security gains in the first quarter.

These security gains and losses are a result of using investment securities as an offset to MSR valuation changes which in recent quarters have fluctuated significantly.

Also there was a $4.1 million decline in auto loan sale gains as the current quarter gains were 4.9 million versus 9 million in the first quarter.

On June 30th we sold 512 million of auto loans resulting in a $5.1 million pretax gain.

During the quarter, at the end of the quarter we transferred $102 million of auto loans to held for sale and posted a lower of cost or market adjustment of $250,000.

These loans are being held for sale in the third quarter.

These 2 transactions resulted in the net $4.9 million of auto loan sale gains.

And lastly there was a $1.7 million decline in broker and insurance income primarily due to lower annuity sales during the quarter.

Slide 17 provides some additional color on our auto loan sales.

As indicated at the top of this slide we've made very good progress in reducing our auto loan exposure -- I should say our auto exposure, towards the 20% target.

Once this 20% target is reached, we expect to continue to sell a portion of current production in order to manage our exposure to this sector.

Slide 18 details some statistics on our mortgage banking and servicing operations.

Mortgage service for investors totaled $6.5 billion at the end June, up 29% from a year ago, reflecting strong demand for residential mortgage loans.

For the quarter, $1.3 billion of mortgages were originated, up 55% from the 860 million originated in the first quarter.

This slide also shows the trends in MSR temporary impairment and impairment recoveries and the use of investment securities to offset MSR valuation changes.

Reflecting the rising interest rates, the MSR at June 30 were valued at 121 basis points up from 93 bases points at the end of the first quarter.

At quarter end the MSR temporary valuation reserve was $1.4 million.

Slide 19 details the trends in noninterest expense.

Noninterest expense trends are also heavily influenced by trends in operating lease expense which accounted for 22% of the quarter's expenses.

Excluding operating lease expense, which will continue to decline along with operating leases, noninterest expense was up $4.6 million, or 2% from the first quarter.

The main driver of this increase was $7.5 million increase in other expense.

This included $5.8 million of costs related to investments in partnerships that generate tax benefits, 1.9 million reduction in personnel cost primarily reflecting lower employer taxes and a $900,000 decline in outside data processing and other services.

Beginning with slide 20 let me review some of the recent credit trend highlights.

Nonperforming asset ratio at quarter end was 34 basis points down from 43 basis points at the end of the first quarter.

Net charge-offs are 23 bases points and included an 18 basis point reduction due to a single 9.7 million commercial loan recovery which was charged off in the fourth quarter of 2001.

90 day delinquencies improved slightly.

And again while our loan loss reserve ratio declined to 1.32% our NPA coverage increased to3.84 times.

Slide 21 shows the charge-off ratio trends for the various portfolios over the last 5 quarters.

C&I net charge-off ratio was a -20 basis points as it included the $9.7 million recovery.

Adjusting to exclude the 70 basis point impact of this recovery C&I net charge-offs would have been 50 basis points.

The total consumer net charge-off ratio was 41 basis points, down from 70 basis points in the first quarter which included 15 basis points related to a 1-time cumulative increase in auto loan and lease charge-offs related to the accounting treatment of certain auto-related insurance policies.

Total net charge-offs were 23 basis points or 41 basis points excluding the impact of the 1 C&I recovery.

Slide 22 is new this quarter and it details our auto loan net charge-off trends for both the on balance sheet and the sold and serviced portfolios.

We added this because the sale of auto loans results in higher reported auto loan net charge-offs.

When a loan portfolio is put together for sale it cannot include any delinquent loans.

In other words, it's a pristine portfolio.

The net charge-off ratio on the on-balance auto loans was 96 basis points in the quarter.

Whereas the net charge-off ratio of the sold and serviced portfolio for the same period was 25 basis points lower or 71 basis points.

Combined, the net charge-off ratio was 83 basis points.

The auto loan net charge-off ratios in the third and fourth quarters are expected to be higher reflecting third and fourth quarter seasonal increases.

Total loan and lease net charge-offs in the second half of the year are anticipated to be in the 40 to 45-basis-point range.

Slide 23 shows a trend in nonperforming assets with the 34 basis point ratio at quarter end representing the lowest level in many years.

This quarter we've decomposed the nonperforming assets into 2 major categories.

Residential real estate, NPAs and commercial and industrial commercial and commercial real estate NPA.

This was done so that you could see that 31% of our nonperforming assets today represent residential real estate assets.

This should give rise to significantly smaller future smaller charge-offs compared with commercial NPAs.

Let me provide a little more nonperforming asset detail on slide 24.

The ending balance declined $17 million from the end of the last quarter.

The level of new nonperforming assets continued to move down.

Also during the quarter we sold almost $15 million of nonperforming assets.

At the end of the quarter as shown on slide 65 in our appendix our largest nonperforming asset was $4.2 million with the second largest under 3 million.

Slide 65 in the appendix shows that 62% of our $51 million of commercial nonperforming assets are below $2 million in size.

Slide 25 recaps the trend in the loan loss reserve which as previously noted declined to 1.32% of loans and leases compared with 1.39 at the end of the prior quarter.

Slide 26 is new, and it decomposes the end of period reported reserve ratio into its 3 components.

It's presented to help you understand exactly what drives our loan loss reserve level and specifically to see what drove this quarter's 7 basis- point decline.

Although we mentioned how these 3 components were determined last quarter it probably bears repeating.

The first component represents transaction reserves.

This component is based on expected losses, determined using historical loss performance.

Specifically the probability of default and the loss and event of default are assigned based on specific characteristics and structures of each loan.

Factors are then applied on an individual loan basis for all loan products.

The second reserve component is the economic reserve which reflects anticipated losses impacted by changes in the economic environment.

As we outlined in our 2003 10-K, beginning this year this reserve component is now determined using a more quantitative methodology.

Specifically, 4 economic indicators have been determined to be statistically significant indicators of loss volatility.

These are the Index of Leading Economic Indicators, The U.S.

Profits Index, the U.S.

Unemployment Index, and the University of Michigan Current Consumer Confidence Index.

The third component consists of specific reserves.

These represent credit by credit reserve decisions for both C&I and commercial real estate loans when it is determined that the related transaction reserve is insufficient to cover estimated imbedded losses.

Now let's look at how these changes in these components resulted in the June 30 reserve ratio of 132, down 7 basis points.

As shown the transaction reserve accounted for 5 basis points of the 7 basis point decline.

The sale of lower performing commercial credits and the release of their inherently higher than average transaction reserve components and the change in the portfolio mix towards higher quality -- higher credit quality loans contributed to this 5-basis-point decline.

Decline in the economic reserves accounted for the remaining 2 basis points of the 7 basis point decline, and that is the product of an improved economic outlook.

As demonstrated this quarter it's important to understand that this methodology will be more responsive to changes in the portfolio mix, our economic environment, and changes in individual credit situations.

It also bears repeating that within the construct of this methodology the conventional notion that provision expense is understated if it does not cover net charge-offs is not valid.

With this methodology, if credit quality trends improve significantly, provision expense could be less than that periods net charge-off, which is exactly what happened this quarter.

Turning to slide 27, last quarter I mentioned that we had removed the allowance for unfunded loan commitments from the total allowance for loan and lease losses with the allowance for unfunded commitments now reported as a separate liability.

Each of these components is separately disclosed at the top of this slide.

However, as both of these reserves are available to cover credit losses and not all banks have adopted this reporting methodology, for analytical and peer comparison purposes we've added these 2 together into a total allowances for credit losses amount.

Which is the third line item on the slide.

The first set of ratios compare our reported allowance for loan and lease losses to period end loan and lease losses and nonperforming assets.

On this basis our period end ratio is 1.32% and our NPA coverage ratio increased to a very strong 3.84% versus 3.22% -- excuse me, 384% coverage versus 322 coverage.

The second set of ratios compares the combined allowance for credit losses to period-end loans and leases and nonperforming assets.

On this basis our period end reserve ratio was 1.46% with a 426% NPA coverage ratio.

Slide 28 and 29 show the trends in 30 and 90 day delinquencies for commercial and consumer loans respectively.

Both C&I and CRE 30 day delinquencies were lower at the end of second quarter and the same trends were noted in the 90 day measurement as well.

Slide 29 shows 30 and 90 day delinquencies for consumer loans while the consumer 30 day ratio moved up a bit the absolute level remained low and the 90 day ratio continued to hold steady.

The main point of these last 2 slides is that delinquency statistics, which in some cases are leading indicators for net charge-offs in coming quarters, continue to improve or remain at absolute low levels.

Let me close with some brief comments regarding capital.

If you turn to slide 30 you will notice that our tangible equity asset ratio as of June 30 was 695, down slightly from March 31.

This remains above our 6.5% to 6.75% target level.

The decline from 7.06% a year earlier primarily reflected the impact of adding back $1 billion of securitized loans in the third quarter 2003 related to the adoption of FIN46.

However, the more telling capital ratio trend has been the tangible equity to risk weighted assets.

The increase in this ratio clearly demonstrates the progress we've made in lowering the credit risk profile of the company.

Here the capital ratio has not been flat but increasing.

This reflect the growth in lower risk residential mortgages and home equity loans, the lowering of our auto loan and lease exposure, and the increasing percentage of investment securities in our earning asset mix.

The point is that we are very well capitalized and we're getting stronger each quarter as we are generating capital internally at a 10% or higher rate.

This completes the financial review, so let me turn the meeting back over to Tom.

Thanks, Mike.

As I noted at the beginning of the call I wanted to close with an update of our outlook for this year's performance.

As shown on slide 32, last April we provided GAAP EPS guidance of $1.71 to $1.75 per share.

As is our practice, at the time we provided this guidance it excluded any impact from future items such as loan sale gains, their timing and amounts were unknown.

We also noted that when such amounts did become certain they would be included in future guidance.

As such, and using our 6 month GAAP earnings of 92 cents per share as a starting point, we're updating our 2004 GAAP guidance to $1.77 to $1.81 per share.

As before, this guidance excludes the impact from any future auto loan sales.

These will be incorporated in future guidance once they are known as would the impact of the Unizan merger once all approvals are obtained.

This completes our prepared remarks.

Mike, Tim Barber, Jay and I will be happy to take your questions.

Let me turn the meeting back over to the operator who will provide instructions on conducting the question-and-answer period.

Operator.

Thank you.

Ladies and gentlemen, at this time if you have a question, please press the 1 key on your touch-tone telephone.

If your question has been answered, or you wish to remove yourself from the queue, please press the pound key.

If you are using a speakerphone please lift the handset before asking your question.

One moment, please, for our first question.

Our first question comes from Fred Cummings Key Bank Capital Management.

Yes, good afternoon.

Hi, Fred.

Fred.

Tom and Mike, can you all talk about, it was very encouraging to see that pick up in commercial loan growth.

Can you talk about the regions if any region was significantly better than the others and how broad-based that growth was with respect to your geographic footprint?

Fred this is Tom.

I would say that it is broad-based spread across our regions, almost all of our regions participated in the growth, and I would say that it's a function of 2 things.

We are beginning to see now the positive impact of some economic improvement.

Although I must say that many of our customers are still in the cautiously optimistic mode as opposed to aggressively moving forward to expand and to need borrowings to fund their expansion.

I do think that the efforts that we've invested in over the last year or 2 to really hone our commercial selling skills and relationship management we believe also are very much paying dividends.

And as you know, we've been through a extended period of kind of refining our approach to shared national credits, that over time has translated into significant declines in balances.

We feel very good about the changing mix in shared national credits.

This quarter basically didn't see much change there, so we allowed, as a result of that, the kind of natural pickup in middle market lending was allowed to be reflected on the balance sheet.

And, Mike, can you touch on the outlook for the margin for the -- I don't know if you gave specific guidance as to what you expect the margin to do in the second half of the year, assuming we get another 25 or 50 basis point increase in rates here?

Fred, we think the margin is near the -- is near bottoming out, that there may be an unintended a little more marginal decline, but we think that the margin is getting near the bottom here.

The mix impact, it's interesting, if you look at our margin over the last year or so, about a little bit over a third of the margin decline has been related to this mix shift, i.e. coming out of auto loans into some investment securities and also strong growth in residential mortgages, both of which obviously have a higher -- or, I'm sorry, have a lower margin than auto loans do.

So -- and that, as you've seen, we've taken our exposure to this auto sector down from 33% to 22%.

We're within seeing distance of our 20% goal.

So that impact will go away as we're going forward.

It won't have the same adverse impact on our margin that it has had over the last 12 to 15 months.

So that factor alone plus, I think, some general increases in interest rates which are at least forecast by the marketplace, if they occur, probably take a little pressure off the margin.

Okay.

Thank you.

Our next question comes from Erik Eisenstein of Standard & Poor's Equity.

Hi, I have 2 questions.

One I was wondering if you could provide any color on any new developments in the SEC investigation, and if you can talk about -- if you can't talk about the substance, maybe as to the timing of when it might be resolved?

And the second question pertains to deposit growth.

It seemed very strong this quarter.

I'm wondering if there was any particular reason for the strength in this quarter that you could think of.

Thank you?

Eric this is Tom Hoaglin.

Relative to your question about the status of the SEC investigation, the investigation remains ongoing.

We continue to be in discussion with the SEC, and that's all the comment that we can make at this time.

Mike, do you want to take the deposit?

Sure.

The deposit growth which was very strong this quarter, we had strong deposit growth in both demand deposits and interest-bearing demand.

I think that you probably want to combine that strong deposit picture with the fact that the last quarter deposits were up maybe at a 1% annualized rate, so 1 quarter probably needs to be averaged out a little bit with that much slower growth rate in the first quarter.

We had deposit growth both on the core -- core deposit growth both on the consumer and on the commercial front, so we felt pretty good about it.

We certainly would not be projecting anything like that going forward.

I might also say, Eric, our deposit growth really, once again, as I responded to the question earlier about loan growth, was apparent in almost all of our regions.

Okay.

Thank you very much.

Our next question comes from Todd Hagerman of Fox-Pitt Kelton.

Good afternoon, everyone.

Hi, Todd.

Most of my questions actually have been answered, but just quickly, Mike, just on that 1 item on the expense side, the 5.8 million investment in the tax vehicle, could you just provide a little bit more color there in terms of what that is and maybe just kind of update us in general?

I know there's been a lot of discussion kind of in the public domain in terms of the IRS and other entities looking at some of these off-balance-sheet tax vehicles and the like.

I'm just wondering kind of what your thoughts are there as it relates to Huntington and your low effective rate and kind of how you guys are positioned going forward?

Todd, you asked a lot of questions.

Let me take the $5.8 million, which was in essence a cost associated with some projects that had tax credits associated with them.

As you're, I think, aware, there are historical tax credits that are available on certain types of investments, and, in essence what we're doing is, in the period in which we recognize the tax benefit of those investments we're writing down the investment of that asset, the costs associated with that.

So we're trying to get them in the same accounting period.

We have not been a significant user of historical tax credits.

We may do some going forward, but that has not been a significant factor or component for us.

Is that the low-income housing tax?

No, it's actually -- there's 2 types of transaction.

There's low-income housing tax credit transactions at which the tax benefit gets spread over the life of the investment, which is typically -- might be 5 to 10 years.

On those investments we would take the -- when we get the tax benefits over that longer time period we would also, in essence, recognize the costs associated with those investments over a corresponding time period.

It's a little different for historical tax credits where you get the tax benefit up-front and, therefore you have to address the cost associated with the investment up-front also.

And then just the second part of my question, just in general terms, I'm just kind of interested in your thought as it relates to kind of the REIT subsidiary structures and the other, you know, tax vehicles that have, you know, come under some scrutiny with the tax authorities and the like?

Just if you have any comments in that respect?

Well, I think if you look at our tax rate, which was -- for the quarter was a little bit over 28%, the tax rate is a function of owning -- having some tax exempt income, bank-owned life insurance tends to be a larger portfolio for us, it's about $950 million.

The relationship to our asset size, than it is for most banks.

So we've got tax-exempt income, some bank owed life insurance, general business credit, which tend to bring that rate down from the statutory rate of 35% into the high 20s.

I'd also comment that with regard to the REIT, that was a transaction that we did in 2001, and actually our IRS audit is complete through 2001.

Okay.

Thank you.

Our next question comes from [Chris Shunard] of Morgan Stanley.

Thank you very much.

Good afternoon, guys.

Hi, Chris.

Hi Chris.

I was wondering if you could comment on the competitive environment for deposits.

As I recall, you've mentioned in the past that the environment has been pretty competitive out there in the Midwest, and also the competitive environment in auto lending.

Chris, this is Tom .

Relative to the competitive environment for deposits, there's no question that it is a competitive environment.

We try to position Huntington's pricing not to be at the top of the market in any of the categories.

At the same time, we understand that we can't ask customers to give up too much in order to do business with us, so we're below the top but still need to be quite sensitive to what's happening in the market place.

There's intense competition but I suspect that the same would be said by our peers in all other parts of the country as well.

I think the other part of your question was the competition for auto lending.

Well, you know, the caps have continued to be very significant competitors.

We've got a number of aggressive bank competitors.

Volumes had been relatively soft in the middle part of the quarter, I think they've picked up a little bit recently.

And here again our strategy is not to be the low pricer in the marketplace.

If we don't think we can get the returns that we need to get we're willing to let the volumes pass by and -- I lost my train of thought here momentarily, Chris.

Leasing, on the other hand, there are relatively few providers in the market.

And as a consequence of that, I don't want to say the competition isn't intense, but there are just fewer of us, and so margins are relatively attractive.

Thanks.

If I could follow up with a quick question, you sold securities this quarter to offset the gain on the -- or the recovery of the MSR impairment, and you took a loss.

I was wondering what type of securities did you choose to sell?

Did that change your position at all?

Did you use this as an opportunity to shorten at all?

We sold 10-year treasuries primarily, Chris.

One point I'd just like to make a comment on, I think there's we've heard some people express some concern that we're increasing the investment portfolio.

At a time of rising interest rates, and, therefore, may be taking on interest rate risk.

As you know, we've sold about $3.6 billion of auto loans over the last year and a half.

And I think the increase in our investment portfolio during that time period has probably been a $1.5 billion, roughly.

So we've replaced some of the auto loans from an earning asset standpoint with investment securities, but certainly not all.

Secondly, I think if you look at our interest rate risk, our net interest income at risk numbers, if we were taking increased interest rate risk you'd see it manifested in that net interest income at risk becoming more liability sensitive.

We've talked on a couple of previous calls about our philosophy with regard to interest rate risk.

So we basically don't want to take any, we don't want to be real asset sensitive or real liability sensitive.

And if you looked at our -We've got a slide in the appendix on that.

If you looked at our interest rate -- net interest income at risk you'd see that it's almost flat line.

So we would disagree with the concern that some have expressed that maybe we're taking interest rate risk.

We've really neutralized the interest rate risk in the company, and that's been true over the last couple of years, basically.

Great.

Thanks.

Once again, if you have a question, please press the 1 key on your touch-tone telephone.

Our next question comes from Ryan [O'Connell] of [A.

B. Anamro.]

Afternoon.

I'd loke to go back just a minute to the remarkable deposit growth you've had.

And I just want to clarify something.

As you define core deposits, does that include or exclude escrow balances on mortgages?

That would include escrow balances on mortgages.

So can you give us some sense for how much of a contribution that made to deposit growth?

I can't tell you off the top of my head.

My guess is that, let's see, mortgage originations were about 1.3 billion this quarter.

I can't remember what they were a year ago.

I'm going to guess they probably were higher but I frankly don't remember.

But as mortgage activity goes down, as interest rates rise, most people would expect mortgage financing activity to decline, and certainly the contribution from escrow deposits would be reduced.

A year ago we had mortgage originations of 1.7 billion, so this year they're actually down $400 million to 1.3 billion.

I think the second point I'd make on that regard is that this is not an enormous part of our business.

We do not have an extremely large mortgage banking area, so it's not having a dramatic impact on our numbers one way or the other.

Okay.

So it's basically good old fashion branch deposits we're talking about.

Good old fashion branch deposits and either middle market companies or, you know, corporations in general.

That's great.

Thanks a lot.

Our next question comes from Matthew Clark of Deutsche Bank.

Good afternoon.

Good afternoon.

Not to beat a dead horse, great quarter, guys.

Thank you.

But can we dive a little deeper into the core deposits?

Could you give us maybe a split between consumer commercial, maybe a split between existing customer growth and new customer growth, and then lastly, related to that, you say that you don't expect this kind of growth going forward.

I guess my question is why not?

What beefed up the second quarter numbers?

Was it some sort of product that you were offering or campaign that you had?

No, it was not a new product that we had.

We've been -- we certainly are -- have a focus on growing deposits.

We've had very strong loan growth, and we need strong deposit growth to certainly fund that.

In terms of -- hold on just a second here.

These are average numbers I'm going to give you.

These are corporate deposits first quarter to second quarter.

Corporate deposits went up about -- a little bit less than $500 million, from 4.5 billion to 5 billion.

Personal deposits went up from 11 billion to about 11.3 billion, so about a 300 million increase.

So we had about 0.5 billion of the increase in corporate, and about 300 million in personal, and those are all what we would define as core deposits which excludes jumbo CDs, any brokered CDs, obviously, and --.

Matthew what I would say with regard to why don't we expect to have the same 19% growth, we would love to have 19% growth quarter after quarter.

We would love to that have on the same basis that we achieved it this past quarter, that is to say not paying at the top of the market price-wise.

But, you know, based upon history, et cetera, it just doesn't stand to robe that we would be able to accomplish that level.

So we're going to work hard to make sure that our deposit growth is strong.

We were just issuing a -- kind of a broad statement that we'd be surprised if it were at that pace on an ongoing basis.

Sure.

And then just new versus existing customers, just a guesstimate as to how much of that growth?

I would say that most of the growth would have come from existing customers.

We're getting better and better at acquiring new households, consumer households.

They were up for the quarter as well as small business households.

But I think most -- I don't have the exact percentage for you, but the majority of our growth in deposit would have come from existing customers.

Okay.

Great.

And then could you just give us what the mark to market adjustment was on the securities available for sale portfolio was and the related duration?

I think the mark to market for the first 6 months of the year between after-tax, for the investment portfolio was 52 million negative and that was offset by 22 million after-tax positive from the mark to market of derivatives.

So you had a net decline in the market value of the investment portfolio and the derivative portfolio after tax of $30 million in the first half of the year.

And I'm sorry I missed your second question.

Duration.

I think the duration of the investment portfolio is about 3 -- a little bit over 3 years.

Compared to first?

I don't have the number.

Okay.

All right.

Thank you.

Once again, if you have a question, please press the 1 key on your touch-tone telephone.

We'll pause one moment.

I'm not showing any further questions at this time.

Would you like to proceed with any further remarks?

Yes, Patty, I think we'd like to go ahead and conclude our conference call.

We do have 1 further question.

Would you like to take it?

Yes.

Thank you.

Steve of [Gresto] of Satellite Assets.

Thanks guys.

Sorry.

I thought I had already toggled in.

Not good, Steve.

Quick question.

You might have already answered this.

I'm not sure if I missed it, but Mike I thought you mentioned that you had sold some nonperformers in the quarter.

Did you quantify that?

And then maybe quantify the loss you took on those nonperformers?

I think, Steve, on one of the slides, slide 24, we show the sales of almost $15 million in the first quarter, 15 million of nonperformers, the loss -- hold on just 1 second.

I don't have the loss number, Steve, off the top of my head.

I'm sorry.

Okay.

Thanks a lot, guys.

Okay.

Well, Patty with that, then, I guess I'd like to thank everybody for participating in our call today.

And if you have further questions or you were unable to toggle in please give myself or Susan a call.

Thank you again.

We'll see you next quarter.

Thank you.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program.

You may all disconnect.

Everyone have a great day.