Huntington Bancshares Inc (HBAN) 2004 Q3 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 Bancshares third quarter 2004 earnings conference call. third 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 star then 0 on your touch-tone telephone.

As a reminder this conference call is being recorded.

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

Mr. Gould, you may begin.

Thank you Patty and welcome everybody.

Again, copies of the slides that we will be reviewing can be found on our website, huntington.com.

And this call is being recorded and will be available as a rebroadcast starting one hour from close of the call 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 play back or should you have difficulty getting a copy of the slides we will be reviewing.

Today's discussion including the Q&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, risks and uncertainties which may cause actual results to differ materially.

We assume no obligation to update such statements.

For a 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 Securities and Exchange Commission including our most recent Form 10-K and 8-K filings.

Let's begin.

Turning to slide 2 presenting today are Tom Hoaglin, Chairman, President, and Chief Executive Officer and Don Kimble, Executive Vice President, Chief Financial Officer and Controller, 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.

And I encourage you to read this.

As always, 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 will be 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 appendix or in the quarterly financial review supplement to today's earnings press release which again 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 one time revenue and expense items on an after-tax base per share basis.

Many of you are familiar with these terms and their usage but for those of you who are not we've provided definitions and rationale for their usage on this slide.

Today's presentation will take about 25 minutes and we want to get to your questions so let's get started.

Tom?

Thank you Jay and welcome everyone.

Thanks again for joining us today.

Turning to slide 4 I will begin with review of significant third quarter events and highlights.

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

I'll wrap up the session with an update on outlook for full-year 2004 performance.

Slide 5 reviews key events and highlights of the quarter.

Earnings were 40 cents per common share down from 47 cents per common share in the second quarter which you may recall benefited from the gain on sale of auto loans, about a penny a share and MSR impairment recovery which added 3 cents per share, recovery of a single commercial credit that also added 3 cents per share.

And these benefits were offset by 3 cents of investment securities losses.

Reported earnings per share in the current quarter included items related to our ongoing SEC formal investigation and the pending merger with Unizan.

First, additional SEC related expenses and accruals adversely impacted earnings by about 2 cents per share.

We remain in negotiations with the SEC regarding a settlement of the formal investigation.

Unfortunately we're unable to predict when these negotiations will conclude.

As announced on June 16 the Federal Reserve Board informed us it was extending its review period for the Unizan acquisition.

Though we can give no assurances at this time regarding the ultimate timing or final resolution of this matter we remain committed to the merger and our integration groups have continued to work to complete all their necessary preparation work.

As such we incurred expenses related to integration planning and systems conversion.

Such expenses cost us about a penny per share during the third quarter.

Originally these expenses were planned to occur post-closing.

Turning now to other items impacting third quarter performance 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 18% excluding the impact of auto loan sales.

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

We were very pleased with another good quarter of growth in small business loans.

Deposits grew at a solid 7% annualized rate with particular strength in non-interest bearing and interest bearing deposits.

Retail CDs grew an annualized 2% reflecting our focused sales efforts and increased effectiveness at growing deposits especially with existing customers.

Our net interest margin improved slightly increasing 1 basis point to 3.30% and leaving us encouraged that the margin will remain around this level over the coming months.

We continue to feel very good about our overall credit quality as reflect in lower loan loss reserve.

Specifically, net charge-offs came in at 30 basis points, higher than the 23 basis points reported in the second quarter.

However, you might remember that second quarter net charge-offs included an 18-basis point benefit from one large commercial recovery.

Excluding the impact of this recovery net charge-offs in the second quarter were 41 basis points.

Our targeted net charge-off range for a stable economic environment is 35 to 45 basis points.

Nonperforming assess increased 5.8 million or 8%.

All of this increase reflected a policy change that added $7.7 million of nonperforming home equity loans and lines secured by real estate that were previously classified as accruing loans and leases past due 90 days or more.

This policy change will be discussed in more detail later.

Without this change current quarter NPAs would have declined nearly $2 million.

At quarter end our NPA ratio remained at a historically low level.

It was only 36 basis points, up slightly from 34 basis points at the end of June but down from 65 basis points at the end of the year ago quarter.

Reflecting these factors and other factors like the improvement in the economic outlook the loan loss reserve ratio declined to 1.25%.

Even so, our reserve position at quarter end was very strong and represented 351% coverage of nonperformers.

During the quarter we also continued to make progress in reducing our auto loan and lease exposure as we sold $153 million of auto loans including 102 million of auto loans transferred to held for sale in the second quarter.

We have sold $3.7 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 of 2002 to 21% at the end of the third quarter, close to our 20% target.

In sum, loan growth and deposit growth were again solid.

We believe the net interest margin is stabilizing which means revenue growth will more closely track loan growth.

Credit quality continued to be positive and period end reserves and capital were at very strong levels.

We feel good about the quarter and continue to believe Huntington remains well positioned for more progress.

Let me turn the presentation over to Don who will provide additional details.

Don.

Thanks, Tom.

As shown on slide 7 reported or GAAP net income was $93.5 million or 40 cents per share.

There were 5 significant items impacting the quarter's results.

First, $5.5 million of pretax expenses or accruals or 2 cents a share related to the ongoing SEC formal investigation.

Second 1.8 million pretax expenses, or roughly a penny per share related to Unizan integration planning and system conversion expense.

The next 3 items are interrelated.

During the quarter, we recognized $4.1 million of pretax or a penny per share of temporary impairment of mortgage servicing rights, or MSRs.

You may recall last quarter we recognized a $10.4 million pretax or 3 cents per share recovery of previously recorded MSR temporary impairment.

This swing between quarters reflected rising mortgage rates in the second quarter followed by declines in the third quarter.

To offset the volatility that results from recognizing temporary MSR valuation changes Huntington has used investment securities and more recently other trading account assets such as forward commitments and options.

As none of these instruments qualify for hedge accounting the change in the value of the trading account assets are reported as a component of other income whereas the gains or losses from the sales of securities that are available for sale are reported as investment security gains or losses.

During the quarter we recognized 7.8 million pretax, or about 2 cents per share of investment securities gains, partially offset by 2.3 million pretax or about 1 cent of trading losses both related to the quarter's MSR impairment.

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 highlights page.

Let me comment on 2 issues.

First you will recall in the 2004 first quarter we separated the allowance for unfunded loan commitments into a liability account distinct from our total allowance for loan and lease losses.

It is important to remember that both of these allowances are available to cover credit losses.

Near the bottom of this slide we show that the loan loss reserve ratio excluding allowance for unfunded loan commitments was 1.25% at September 30 but was 1.38% when it is included.

Second, there has been an upward trend in intangible common equity to risk weighted assets shown at the bottom of the slide.

The quarter end ratio was 7.8% up significantly from a year ago.

This improvement is due in large part to the lower risk nature of balance sheet compared with a year ago.

Since I will be covering most of these items in detail later let's move on to the next slide.

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

Compared with the second quarter net interest income increased $4.5 million, or 2%, showing benefit of growing loans and other earning assets and the 1 basis point improvement in net interest margin.

Notable was $6.8 million increase in the provision for credit losses.

Primarily reflecting lower recoveries in the third quarter.

You might recall that the second quarter provision expense was impacted by a single $9.7 million commercial loan recovery.

The changes in noninterest income and noninterest expense continue to be impacted by the runoff of operating leases.

More on that later.

The table on slide 10 shows a trend in reported EPS as well as the significant items impacting quarterly performance comparison.

You will note the year-ago quarter reported EPS of 39 cents a share was negatively impacted by 6 cents related to the cumulative impact of adopting FIN 46 but positively impacted by 4 cents from the gain on sale of West Virginia banking offices and a net 4 cents from recovery of MSR temporary impairments.

Further, the second quarter's reported 47 cents a share benefited from 3 cents from a single C&I recovery and a penny from the sale gain on auto loans.

Slide 11 shows the third quarter net interest income, on a fully tax equivalent basis, increased 3% from the year-ago quarter.

Notably, net interest income on a fully taxable equivalent basis increased from the second quarter after being basically flat on a dollar basis for the last 3 quarters.

Reflecting the impact of increasing the balance sheet while maintaining a stable net interest margin.

A significant factor in the generally downward trend of net interest margin in prior quarters has been significant shift in the composition of our balance sheet toward less risky lower yielding assets both loans and securities.

Importantly with a stabilizing margin net interest income growth will more closely reflect growth in loans and leases.

Slide 12 illustrates the net interest income at risk assuming a gradual 200-basis-point increase in interest rates from those implied by the forward curve and a gradual 100-basis-point decrease in interest rates also from that implied forward curve.

We model at 100 basis points rather than 200 basis points and interest rates implied by the forward curve given the absolute low level of interest rates.

As you can see we are relatively interest rate neutral with a .3% positive impact of net interest income if rates increase by 200 basis points given the current assumption and a .5% negative impact to net interest income if rates decline by 100 basis points.

Slide 13 illustrates the change in the loan portfolio mix over the last to lower margins, lower risk credit.

We have talked previously today about the auto lone exposure reduction from 33% at the end of 2002 to 21% at the end of September as shown in the shaded box at the bottom of the slide.

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

As shown in the shaded box in the middle of the slide.

Combined, these 2 portfolios have increased from 23% at the end of 2002 to 34% of the total credit exposure at the end of September.

The changes made in our portfolio mix position us well for future loan charge-offs thus requiring lower levels of loan loss reserves.

Average loan and lease growth is highlighted on slide 14.

This shows that total average loans and leases increased 8% to $22.2 billion but as footnoted here the underlying annualized growth rate was a very strong 18% after giving consideration to the impact of automobile loan sales.

Reported average middle market C&I balances showed a significant decline with middle market loans CRE loans showing a marked increase from second quarter.

These results were impacted by a June 30 2004 reclassification of $282 million of C&I loans to CRE loans.

Adjusting for this reclassification, average middle market C&I loans were essentially flat, following a 10% annualized growth rate in the second quarter.

We begin to see indications for demand for C&I loans late in the first quarter and into the second quarter so utilization rates have remained relatively stable.

Adjusting for same reclassification middle market commercial real-estate loans were also essentially flat.

Small business C&I and CRE loans made through our retail delivery channels grew at an encouraging 14% annualized rate and 11% versus a year ago we continue to be pleased with our progress in growing this important business segment.

Auto loans declined significantly reflecting impact of $512 million auto loan sale late in the second quarter and the third quarter's auto loan sale of $153 million.

Excluding these sales, the underlying auto loan growth rate would have been a positive 9%.

Auto direct finance leases average $2.3 billion in the third quarter, a 21% annualized growth rate.

Operating lease assets classified as nonearning assets and listed near the bottom of the table continued to run off and averaged $800 million.

As previously disclosed auto leases originated since April 2002 have been booked as direct financing leases.

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

I refer to you slide 54 and 55 in the appendix for additional information about the auto loan and lease trends.

Home equity loans and lines and residential mortgages, primarily adjustable rate mortgages, continued their strong growth up 15% and 70% on an annualized basis respectively from the second quarter.

Slide 15 provides a reconciliation of the impact on auto loan sales on the third quarter growth rates for auto loans as well as total loans and leases which, when adjusted, had an annualized growth rate of 9% and 18% respectively.

In sum we are very pleased with our ability to continue to grow loans.

To date this growth has been dominated by home equity and small business loans.

We expect mortgage loan growth to slow and C&I lending to continue to show only modest growth.

Slide 16 provides some additional color on our auto loan sales.

As indicated at the top of the slide we have made good progress in lowering our auto exposure toward our 20% target.

Once our 20% target is reached we expect to continue to sell a portion of the current production in order to maintain our exposure to this sector near our targeted level.

So the level of the sale activity going forward may be more infrequent and will be driven by auto loan production levels.

Slide 17 shows that total core deposits increased an annualized 7% from the second quarter and were up 4% from a year ago quarter.

Although growth in noninterest bearing and interest bearing demand deposits were down from the very strong growth rates experienced in the second quarter we are very pleased with the third quarter growth in these deposits up 7% and 12% respectively on an annualized basis from the second quarter.

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

In the third quarter we saw an annualized 2% growth rate in CDs.

Following a flat level of growth in the second quarter which reversed the net quarterly declines previously.

Growth in commercial deposits continued to be particularly strong.

Slide 18 reviews the trends in the noninterest income.

Total noninterest income declined by $28.2 million, or 13% from the second quarter, operating lease income accounted for 34% of noninterest income down from 36% in the second quarter.

By the end of next year operating leases will have declined to a point where their accounting impact on our income statement and on our balance sheet trends will be insignificant.

Excluding the decline in operating lease income total noninterest income declined by $13.9 million from the second quarter.

The main drivers of this decrease were an $18.9 million decrease in mortgage banking income.

With the current quarter included a $4.1 million MSR temporary impairment compared with a $10.4 million recovery of previously recorded MSR impairments recognized in the second quarter.

Excluding the MSR impairment valuation change between quarters mortgage banking income decreased $4.4 million primarily reflecting lower secondary marketing gain. $6.8 million, or a 27% decrease in other income.

This reflected a $2.3 million MSR-related trading losses in the current quarter as well as a decline in investment banking and trading fee income.

A $4.6 million decrease in gain on sale of automobile loans as the current quarter reflect $300,000 of gain compared with $4.9 million in gains in the second quarter.

These decreases were partially offset by a $17 million increase in net security gains as the current quarter included $7.8 million of security gains compared with $9.2 million of security losses in the second quarter.

These security gains and losses reflect the investment securities used as an offset to the temporary mortgage servicing right valuation changes which over the last several quarters have fluctuated greatly.

Slide 19 shows some statistics on our mortgage basically and services operation.

Mortgages serviced for investors total $6.8 billion at the end of September up 13% from a year ago reflecting the strong demand for residential mortgage loans.

For the quarter $1.1 billion of mortgages were originated, down 21% from the second quarter and down 52% from a year ago quarter.

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

Reflecting lower interest rates MSRs as a percentage of investor servicing portfolio at September 30 were valued at 113 basis points down from 121 basis points at June 30.

At quarter end the MSR temporary valuation reserve was $5.5 million.

Slide 20 details trends in noninterest expense.

Total noninterest expense declined $8.7 million or 3% from the second quarter.

Noninterest expense trends also were heavily influenced by trends in operating lease expense which accounted for 20% of quarter's expenses down from 22% in the second quarter.

Excluding operating lease expense which will continue to decline along with operating leases noninterest expense declined $1.1 million from the second quarter.

The main drivers of this decline were $3.7 million or 14% decrease in other expense.

As a second quarter included $5.8 million of costs related to investments and partnerships generating tax benefits for the first half of 2004.

For the 2004 third quarter other expense included automobile lease residual value losses as well as SEC-related expenses and accruals. $3.1 million a 38% decrease in our marketing expense was also recognized during the quarter due to lower advertising expenditures and a $1.2 million benefit from the release of the restructuring reserve also incurred in the quarter.

This decline was a partially offset by $4.4 million or 56% professional services primarily reflecting SEC-related expenses.

Also a $2 million or 2% increase in personnel cost.

The current quarter also included $1.8 million of expenses related to Unizan integration planning and systems conversion.

These expenses were spread across various noninterest expense categories with no meaningful impact on any single line item.

Beginning with slide 21 let me review some of our recent credit trend highlights.

The nonperforming ratio at quarter end was 36 basis points up slightly from 34 basis points at the end of the second quarter but still historically low level.

Net charge-offs were 30 basis points compared with 23 basis points in the second quarter which included an 18 basis point reduction due to a single $9.7 million commercial loan recovery previously charged off in the fourth quarter 2001. 90 day plus delinquencies were unchanged from the second quarter but improved 7 basis points from the year-ago quarter.

Our loan loss reserve ratio declined to 1.25% while NPA coverage remained very strong at 351%.

Slide 22 shows the charge-off ratio trends for various portfolios over the last 5 quarters.

The total commercial net charge-off ratio was 10 basis points reflecting improvement in both C&I and CRE charge-offs.

As noted in the footnote the second quarter C&I net charge-offs included a $9.7 million recovery.

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

The total consumer net charge-off ratio was 45 basis points up slightly from 41 basis points in the second quarter.

We anticipate a slight increase in the consumer net charge-off ratio in the fourth quarter due to seasonal factors impacting mostly auto loans and leases.

Total net charge-offs were 30 basis points below our long-term targeted net charge-off range of 35 to 45 basis points in a stable economic environment.

Slide 23 details auto loans net charge-off trends for both the on balance sheet and sold and serviced portfolios.

We show this slide because, all things being equal, the sale of automobile loans results in higher reported auto loans net charge-offs.

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

The net charge-off ratio for the on- balance sheet loans was 111 basis points in the third quarter whereas net charge-off ratio for the sold and serviced portfolio for the same quarter was 36 basis points lower, or 75 basis points.

For the total managed portfolio the net charge-off ratio was 89 basis points.

Slide 24 provides an update on our automobile lease residual value insurance coverage designed to mitigate losses on our automobile lease portfolio.

In sum we have 3 residual value insurance policies each a bit different.

Residual value losses on automobile leases booked prior to October 1, 2000, were covered by the assumption insurance policies with $120 million loss cap.

As previously noted we'd anticipated residual value losses to exceed this cap some time later this year or early next year.

However, residual value losses were such that the cap was exceeded during the third quarter which was earlier than anticipated and was due to a higher than expected volume of turned in vehicles and to a lesser degree softness in the used-car market.

Total losses above the cap are expected to be in the $18 to $30 million range including $10 million already recognized and reflected in additional accumulated depreciation expense.

As a result, we currently anticipate the fourth quarter operating lease depreciation expense will be $2 to $3 million higher than the third quarter expense level with lesser amounts in quarters thereafter.

The residual value insurance policy covering automobile leases originated between October 1, 2000, and April 30, 2002, contains a $50 million cap on residual losses.

At this time we anticipate total claims against this policy will be in the $10 to $18 million range, well below the cap.

To date we have filed claims of approximately $3 million on this policy.

All automobile leases originated since April 30, 2002 are covered under a policy that does not place a cap on losses.

This policy will not expire until April 30 of 2005.

Just as a reminder slide 25 shows our long-term net charge-off categories by loan category.

Assuming a stable economic environment.

Within this type of an environment we would expect long-term total charge-offs to be in the 35 to 45 basis point range.

On slide 26 we show the trend in NPAs.

As you can see third quarter NPAs as a percentage of total loans and leases and other real estate was 36 basis points up only slightly from the second quarter level of 34 basis points.

At September 30, 2004, the Company adopted a new policy of placing home equity loans and lines on non-accrual status when they exceeded 180 days past due.

Such assets were previously classified as accruing loans and leases past due 90 days or more.

This policy change conforms the treatment of home equity loans and lines to that of other consumer loans secured by residential real estate.

As a result of this change in policy the third quarter included $7.7 million of non-performing home equity loans and lines secured by real estate.

This reclassification does not reflect a change in credit quality or expected loss rate.

We have de composed NPAs into major categories: Residential real estate related NPAs and commercial NPAs.

By decomposing the NPAs in this manner you can see that 38% of our NPAs today represent residential real-estate assets.

This is up from 31% in the second quarter in part reflecting the addition of $7.7 million in non-performing home equity loans and lines.

And up from 14% in the year-ago quarter.

Such assets should give rise to much smaller charge-offs compared with - - or excuse me, compared with commercial NPAs.

Let me provide a little more non-performing asset detail - - excuse me, on slide 27.

The ending balance increased $5.8 million from the last quarter.

Importantly, the level of new NPAs continued to move down even including the additional $7.7 million of home equity NPAs discussed above.

At the end of the quarter our largest NPA was $4.2 million as shown on slide 68 in the appendix, 52% of our $50 million of commercial NPAs are below $2 million.

Slide 28 recaps the trend in loan loss reserve as previously noted declined to 1.25% of loans and leases compared with 1.32% at the end of the third quarter.

You will recall the lower net charge-offs in the second quarter reflected a one time $9.7 million recovery.

It is worth noting on the slide that the gross charge-offs in the third quarter continued their downward trend.

Slide 29 was new last quarter and decomposes the end of the period reported reserve ratio and its 3 components.

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

Though we mentioned how these 3 components are determined last quarter it bears repeating.

The first component is transaction research.

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

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

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

The second reserve component is the economic reserve which reflects the impact on anticipated losses of changes in the economic environment.

As outlined in our 2003 Form 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.

Profit Index, the U.S.

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

The third component is a specific reserve.

This represents credit by credit reserve decisions for C&I and CRE loans when it is determined that the related transaction reserve is insufficient to cover estimated embedded losses.

Now let's look at changes each of of these components and how it resulted in a September 30 reserve ratio of 125 basis points down 7 basis points.

As shown the transaction reserve accounted for 2 basis points of the 7 basis point decline, the change in the portfolio mix toward higher credit quality loans contributed to this decline.

The decline in the economic reserve accounted for 3 basis points of the 7 basis point decline.

This reflected different influences from each of our 4 factors used in evaluating this reserve component.

Contributing to need for lower economic reserve was an increase in the U.S.

Corporate Profits Index and a decline in the U.S.

Unemployment Index.

Partially offsetting these influences were declines in the Consumer Confidence Index and Index of Leading Economic Indicators.

The balance of the decline in the reserve ratio can be accounted for by a 2 basis point decline in the specific reserves reflecting improvement in credit quality of individual and commercial credit situations.

As demonstrated again in this quarter it is very important for investors to understand that this methodology will be more responsive to changes in the portfolio mix, our economic environment and changes in the individual credit situation.

Slide 30 is new this quarter and has been designed to provide a reconciliation in the change in our loan loss provision in the third quarter compared with the second quarter.

Given our new loan loss reserve methodology, we felt this might be helpful, especially since the conventional notion of provision expense is understated if does it not cover net charge-offs, it is not valid under our new reserving methodology, in the light of my comments regarding the 3 reserve components just a moment ago.

As shown at the bottom, the total loan loss provision in the third quarter was $11.8 million.

Let me review what made up this expense.

First, as shown at the top, we begin with an amount equal to the $16.5 million of net charge-offs.

Next, with a $2.2 million addition in the required transaction reserve, this reflected a combination of factors including growth in total loans and leases and changes in the portfolio mix, changes in the portfolio loan grade migration.

Next, with a reduction in the economic reserve component reflecting a change in the 4 components mentioned a moment ago.

And last was a lower specific reserve requirement reflecting improved C&I and CRE quality for individual credits.

Summed together the result was a required provision expense of $11.8 million.

Turning to slide 31 allowance for unfunded loan commitments is shown separate from the total allowance for loan and lease losses at the top of the slide as the allowance for unfunded loan commitments is reported separately as a liability.

However, as both of these reserves are available to cover credit losses and not all banks have adopted this reporting methodology for analytical and comparison purposes we have added these 2 together into a total allowance for credit losses which is the third line on this slide.

The first set of ratios compares our reported allowance for loan and lease losses to period end loans and leases and NPAs.

On this basis our period end reserve ratio was 1.25% and even though our NPA coverage ratio declined it remained very strong at 351%.

The second set of ratios compares the combined allowances for credit losses to period end loans and leases and NPAs.

On this basis our period end reserve ratio was 1.38% with a 389% NPA coverage ratio.

We believe these ratios are more comparable to what most of our peers report.

Let me close with some brief comments regarding capital.

Turn to slide 32, you will notice that our tangible equity to asset ratio as of September 30 was 7.11% up from June 30 This continued to be well above our 6.5% to 6.75% targeted level.

However the more telling capital ratio trend has been the tangible equities to risk-weighted assets which has steadily increased to 7.80% from 7.24% one year ago.

This increase in the ratio clearly demonstrates the progress we have made in lowering credit risk profile of the Company as reflected in the growth and lower risk residential mortgages and home equity loans.

The lowering of our automobile loans and the lease exposure and the increased percentage of investment securities in our average earning asset mix.

This is now reflected in our lower net charge-offs.

We are very well capitalized and are getting stronger each quarter as we have generated capital internally at an average rate of 10% over the last five quarters.

Slide 33 shows graphically significant increases in tangible equity to asset ration and the tangible equity to risk weighted asset ratios over the past year.

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

Thanks, Don.

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

As shown on slide 35 in July we provided revised GAAP EPS guidance of $1.77 to $1.81 per share.

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

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

Using our 9 month GAAP earnings of $1.32 per share as a starting point we're updating our 2004 GAAP guidance to $1.75 to $1.77 per share implying fourth quarter earnings guide of 43 cents to 45 cents per share.

While this full-year guidance is below our earlier guidance it reflects actual third quarter performance, not a change in fourth quarter expectations.

As before this guidance excludes the impact from gains or losses associated with loan sales, if any, these will be incorporated in future guidance once they're known.

In addition this guidance excludes fourth quarter SEC or Unizan related expenses as a fourth quarter impact is unknown at this time.

This completes our prepared remarks.

Don, 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, if you have a question at this time, 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.

One moment, please.

Our first question comes from Fred Cummings of Keybanc Capital.

Yes.

Good morning.

Don, can you review these SEC expenses?

I want to make sure I fully understand them.

Did you accrue a total of 5.5 million in this quarter?

And then can you describe what type of costs - - can you just be a little more specific in terms of what type of expenses - - what's causing these accruals, what's the nature of these expenses?

Fred this is Tom.

Let me intercede for Don.

We are not going to provide any breakdown of what's in the total but you could generally think of these as being comprised of a various list of legal and other expenses but no specific detail.

Okay.

And looking - - in terms of the magnitude, Tom, was that right, 5.5 million in this one quarter here?

Yes, that's correct, Fred.

And then looking forward, looking at expenses, with respect to maybe hiring staff and internal audit and now you've added a Chief Risk Officer, what would you anticipate the investment needed to be to support this new Chief Risk Officer?

Hard to say.

We don't think it will materially impact at all our personnel expenses, and we're going to continue to incur SEC investigation related expenses at some level, albeit we have no idea what it would be, until the investigation is concluded.

But on one the hand we're really excited about having Jim Nelson join us.

On the other hand, we - - it reflects a heightened commitment to the practice of risk management.

We just don't expect that it will result in any material impact in our overall expense level.

Okay.

Thanks, Tom.

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

We'll pause one moment.

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

Good morning, everybody.

Good morning, Todd.

Couple of questions.

One, maybe, Don, just going back to that discussion on the reserve and the reconciliation and the reserve, I'm just trying to tie in on the income statement in that restructuring reserve release, I thought it was my understanding previously that was separate and apart from the portfolio and wasn't factored into the new unallocated.

Am I missing that, or --.

There's 2 different items there.

There's a $1.2 million for the restructuring reserve release would flow through the other expense categories as opposed to through our provision.

Okay.

And, again, so that, just looking at it from quarter to quarter, we should expect that to be somewhat - - it will be variable, you know, going forward?

Yeah, we wouldn't expect any additional releases there at this point in time as far as releases from the restructuring reserve.

The portion that is variable is just the provision expense and it reflects the impact of the economic changes and also the impact of changes in our overall portfolio quality.

Okay, great.

Then if I could just follow up with respect to the change on the home equity portfolio, just looking at the charge-off line and the increase in the home equity portfolio this quarter, you know, it's falling outside kind of your normalized charge-off level.

How much was the quarterly increase in the home equity related to the policy change?

If any.

There was about $300,000 worth of charge-offs.

Todd, let me ask Tim Barber to respond, too.

Sure.

Todd, I would say that the increase was almost completely a function of the change in the denominator of the calculation.

So for the home equity portfolio we pulled out the dollars, moved it to residential and the resulting calculation indicated a higher number.

Doesn't represent a change in the quality of the portfolio.

Right, but then just on a go-forward again we should expect that to kind of moderate?

I would say that's correct, yes.

That's it.

Thank you very much.

Thank you.

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

We'll pause one moment.

Our next question comes from Heather Wolf of Merrill Lynch.

Hi, good morning.

Good morning, Heather.

A few questions here.

First, in terms of the Unizan integration, have you started any balance sheet restructuring?

No, we have not.

Okay.

So could we assume, then, that the impact on the - - on your tangible equity ratio would still be about the 33 basis points that you announced when you announced the acquisition?

Yes, that's correct.

Okay.

So that, if I calculate correctly, would put your capital ratios at the top end, or actually a little bit above the top end of your range.

Can you discuss your plans for the excess capital?

Heather, this is Tom.

We certainly recognize the level and trend in the capital ratios.

At this point in time we don't have any specific thing to say with regard to how we might utilize the excess capital.

I can only say that it's something that we're looking at.

And there are obviously a variety of alternatives open to us but we need to get through issues like the SEC investigation before we bring added clarity to that.

Okay.

And one other question.

I noticed that your deposit pricing on your interest-bearing accounts ticked up pretty meaningfully this quarter.

Can you discuss why and the environment you're seeing for deposit pricing?

Are you noting anything specifically?

We show our total deposit rates going up about 7 basis - - or core deposits up about 7 basis points and total deposits up about 10 basis points.

I was actually just looking at the interest-bearing demand deposit.

Heather, we're turning, as we speak, to the numbers here.

Okay.

Did see about 25-basis-point increase there.

And most of that, I believe, was driven by mix change within the interest-bearing demand deposits.

And we can get a little bit more information for you later on that if you would like.

Okay.

That would be great.

Thanks.

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

Our next question comes from Matthew Clark of Deutsche Bank.

Hey, good morning, everyone.

Hey, Matthew.

Can you just touch on commercial lending here, C&I in particular?

It looks relatively flattish sequentially, and I think a lot of your Midwest peers, or a handful of them this quarter have seen some acceleration.

Just wondering what's going on there, if you could dig a little deeper.

Matt, this is Tom.

What I would say is that our experience is that we have - - we feel like we've got pretty reasonable pipelines, much in our pipelines relates to the acquisition of new business as opposed to expansion by existing customers.

And by and large our customers commonly in - - excuse me, we're having - - by and large our customers in Ohio and Michigan are saying to us that they're still pretty cautious.

They're not willing to either commit resources or to ask for resources from us for the acquisition of capital equipment or expansion of their facilities.

So we're seeing caution.

We believe that there will be a time where we'll get some modest commercial pickup.

We're not counting on anything substantial in the next quarter or so.

As you know, we have worked very hard over the last couple of years to reposition our whole C&I, not only our book but how we approach C&I business.

We're really focused on what we call the ideal Huntington client.

And we're aggressive in seeking business but we're also not willing to stretch abnormally either on price or on structure, which we see happening in some areas.

So we feel fine about C&I.

We think we will get some growth, but our customers are still expressing caution at this point.

And on the deposit pricing, which I think was just asked a little bit here, what are you guys doing on that side?

Are you feeling the need to raise prices on that side of the business?

It does appear that one of your competitors is doing some of that locally.

Matt, Tom again.

Our approach is that we don't price deposits to be at the top end, we'd be more middle or above middle, but not at the top.

Clearly a short-term rates have gone up, we and others have increased our prices on short-term deposit products, but we have not taken the position we need to move in lock-step with the Fed with regard to our short-term deposit prices.

So they're higher than they were and we're pricing ourselves between the middle and high end of the market.

On auto pricing is it still outrageous from a competitive perspective?

Are you guys still pulling back?

This is Tim Barber.

I think - - you're talking about the auto portfolio pricing?

Yes.

Is is that correct?

We're still seeing very significant competition from the captives, primarily.

They've got low rates and have combined that with incentives.

We're doing what we can within our credit and pricing disciplines.

With that being said, Matthew, you'll note our production levels are down again this quarter compared to previous years.

So we're not trying to chase that with price, just like we had the comments on the commercial side as well.

Right.

Okay, thank you.

Uh-huh.

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

But if you would like to ask a question, please press the 1 key.

Our next question comes from Christopher Chouinard of Morgan Stanley.

Hi.

Thank you.

Good morning, guys.

Good morning, Chris.

I had a question on the residual value insurance policies and the extent to which they're expecting to exceed the cap on that $120 million assumption policy.

How much was the impact this quarter of that, and where did it flow through?

And I have a follow-up question as well.

This is Tim.

We did show total depreciation expense associated with that excess of about $5.2 million this quarter and we also had an additional $2 million of impairment losses recognized during the quarter as well.

As we said earlier in the slide we would expect that depreciation expense to go up by $2 to $3 million next quarter and then show less of an impact in future quarters after that.

So when you say go up by $2 to $3 million, then less going forward, you mean it would stay at sort of that $8 million rate for a couple of quarters?

It would stay at that $8 million rate in the fourth quarter, and I believe it would even trend down after that just because the portfolio continues to run off, so we wouldn't see significant increases from that point forward, is our expectation.

I see.

And the $2 million - - I'm sorry, the 5.2 million would have been included in, I guess, the operating lease expense and noninterest income?

It's in the noninterest expense, operating lease expense, that's correct.

And then the 2 million would have been in other expense?

That's correct.

Oka.

And if I could just follow up on the question on C&I loan growth, you know, Tom, you mentioned that customers are, you know, somewhat cautious in terms of investing in new equipment.

What are you hearing from customers about energy prices, and is that - - how much of a concern is that to them, you know?

And do you think any of this is driven by the election, either just people waiting to --?

Chris, we are not hearing the latter.

That is to say, we are not hearing any caution that might be election dependent.

What we are hearing, particularly in heavy manufacturing regions like northeast Ohio, or southeast Michigan, is discouragement with regard to energy prices in many businesses this is having a very significant negative impact, compromising margins to say the least.

And I think underscoring the caution that businesses feel.

I've heard from business people in those markets that it's been a long time since they've seen business conditions as weak as they have, energy is certainly affecting that.

Great.

Thanks a lot, guys.

Our next question comes from Kevin Reevey of Ryan Beck.

Good morning.

Good morning, Kevin.

I just have a couple of questions regarding your fee income line items, service charges on deposit accounts.

That was up very, very modestly.

I would have expected it to be up more given your deposit growth.

Can you give us some color on that?

We saw the service charge income increase, and it's more closely tied to some of our noninterest bearing deposit balances as opposed to overall balances.

We showed lower growth in the service charge income than the noninterest bearing deposits but not significantly different.

And then on your BOLI income was down about 11% linked quarter.

Can you give us some explanation of what was going on, on that line item?

There were some benefits realized in the second quarter associated with some true-ups on some estimated losses through the policy.

And as a result, income was higher in the second quarter than what it was in the third quarter.

The other issue that you'll continue to see there, is it's based on long-term market rates of interest, so we'll see that crediting rate continue to drop for a little while as the long-term rates settle into some more current levels.

Thank you.

Our next question comes from Cameron Hurst of Portals Partners.

Good morning.

Good morning.

I was hoping you could comment on, given, I guess, the heightened environment for M&A that's definitely involved in the Midwest, on your policy on acquisitions as well as your philosophy or your thinking about remaining independent?

Our policy on acquisitions, Cameron, is that we need to get through the resolution of the SEC investigation to gain banking regulatory support for doing acquisitions.

That may seem obvious, but until we are through the current situation, there's no value in our having any discussions with anybody else.

Just in general, we have a pretty clear set of criteria, as we think about acquisitions and we fully expect to resume acquisitions at some point, and those criteria are first and foremost to enhance market share in existing markets.

We're not inclined to go elsewhere at this point in time but we do recognize that we need to be bigger in many of our markets.

We'd like very much to acquire management.

We'd like very much to have low or manageable execution risk.

And we want to be disciplined in pricing so that we don't expect to do any transactions in the future that would be dilutive in nature even in the first year.

Even in the first year?

That's correct.

That is excluding the impact of any up-front charges and so forth.

Okay.

My attitude there, Cameron, is that this Company has come a long way over the last few years, and we want to be disciplined in pricing so that we don't impact our shareholders who have seen significant improvement in their value over the last few years.

Our position with regard to independence, which is the last part of your question, is we're here to deliver attractive value for our shareholders.

We feel that we've done that very much in '02, '03, and thus far in '04.

We're quite competitive or more so with peers.

This management team and Board have great confidence that we're going to be able to continue to do that.

At such point in time as we demonstrate an inability to do that we obviously have to look for other ways of generating value for our shareholders.

But we think our current course of action is the right one.

Is there, I guess, a level that you have that beyond which it would just make sense if someone, you know, was pricing a deal irrationally or exuberantly that you would more through some sort of fiduciary responsibility be obliged take that to your Board?

We don't have any thinking on that.

Well, thank you.

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

Would you like to continue with any concluding remarks?

Yes, we'd like to conclude, Patty, if we may.

Everybody, we want to thank you very much for participating in our call this quarter.

If you have follow-up questions, certainly Susan and I are standing by to take them.

Please give us a call.

Thanks again and we will see you next quarter.

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

This concludes the program.

You may all disconnect.

Everyone have a great day.