Huntington Bancshares Inc (HBAN) 2006 Q2 法說會逐字稿

Good afternoon my name is Judy, and I'll be your conference operator today.

At this time, I would like to welcome everyone to the Huntington Bancshares' second quarter earnings conference call.

[OPERATOR INSTRUCTIONS].

Thank you.

I will now turn the call over to Mr. Jay Gould, Director of Investor Relations.

Sir, you may begin your conference.

Thank you, Judy, and welcome everyone.

Copies of the slides we will be reviewing can be found on our website, and as-- as is typical this call is being recorded, and would be available for rebroadcasting about an hour from the close.

If you have any difficulties getting copies of the slides or recordings for playback, please call the Investor Relations department.

Slide 2 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 both GAAP 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 a reconciliation to the comparable GAAP financial measure can be found in this slide presentation in its appendix in the press release, or in the quarterly financial review supplement to today's earnings press release, all of which are on our website.

Second, and most important, is how we're going to talk about the impact of the Unizan merger on our reported results.

This merger, you'll recall closed on March first.

The Unizan merger did not have a material impact on last quarter's results or related performance comparisons, as that quarter included only one month of Unizan results.

However, this quarter's results include a full quarter impact of three months, so while Unizan's full run rate impact was reflected in the second quarter results and will be going forward, it does materially impact performance result comparisons on a link quarter and year-over-year basis.

We therefore think it's helpful to investors and analysts to isolate this impact so that this quarter's underlying trends can be better understood.

To accomplish this we have adopted three terms in referring to estimated impact from the Unizan merger.

These terms as well as the methodology used to estimate any impact on the merger are fully explained on this slide, but in sum the term merger adjusted refers to amounts and percent changes that represent reported results adjusted to exclude the impact of the merger.

The term merger related refers to amounts and percent changes representing the impact attributable to the merger.

In addition, we also use the term "merger costs" to refer to expenses associated with the merger integration activities such as the payment of retention bonuses.

This term is used exclusively in non-interest expense discussions.

For a frame of reference we had $2.6 million of such merger costs in the current quarter and $1.0 million in the first.

The slide explains the methodology used for making these estimates.

Please take time to review it.

Slide 3 reviews additional aspects on the basis of today's presentation and discussion.

Certain performance data we will review are shown on annualized basis and the discussion of net interest income.

We do this on a fully taxable equivalent basis.

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

Many of you are familiar with these terms and their usage, but for those of you who are not, we have provided a definition and rationale on this slide.

Today's discussion, including the Q&A period, may contain forward-looking statements, defined by the Private Securities Litigation Reform Act of '95.

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 the risks and uncertainties please refer to this slide as well as material filed with the SEC.

Let's begin.

Turning to slide 5, presenting today are Tom Hoaglin, Chairman, President and CEO and Don Kimble, Executive Vice President and Chief Financial Officer.

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

Let's get started, Tom?

Thank you, Jay, and welcome everyone, we appreciate your joining us again today.

Turning to slide 6, I'll begin with a general overview of the quarter's highlights and Don will review the quarter's financial performance and then I'll close with an update on our outlook for full year 2006 and moderate the Q&A.

Turning to slide 7, earnings were $0.46 per share, up $0.01 from the first quarter.

This exceeded our expectations slightly.

We believe it represents a solid quarter.

Our net interest margin increased 2 basis points from the last quarter.

I find it noteworthy that while many banks have been reporting margin declines over the last several quarters, our margin has been relatively stable.

Over the last 10 quarters, our net interest margin has remained within a narrow range of 3.29% to 3.38%.

This reflects our focus on loan and deposit pricing as well as effective interest rate risk management.

Our outlook is for continued stability.

Average total loans and leases grew at 3% merger adjusted annualized rate.

We were especially pleased with the merger adjusted 11% annualized growth rate in total average commercial loans.

Growth was evident in all three commercial loan categories.

Little market, CNI, small business and commercial real estate.

Our commercial line utilization rate increased almost 2 percentage points from the first quarter and our pipeline at quarter end was strong again this quarter.

The tough competitive environment continued to make growing residential mortgage and home equity loans a challenge.

Merger adjusted average residential mortgages increased at a 5% annualized rate, which was above the annualized rate of last quarter.

Mortgage loan volume, while still low in absolute terms increased 39%.

Merger adjusted average home equity loans increased at a 3% annualized rate, which compares favorably with the annualized decline in the first quarter.

These results and more modest growth rates reflected the continued impact of hire interest rates, our disciplined underwriting and pricing strategy, as well as a decision to deemphasize the broker business.

On the deposit side, total average core deposits declined at a merger-adjusted 1% annualized rate.

Like last quarter, this quarter's performance reflected movement of deposits out of lower cost savings accounts and into higher rate CD's.

While overall merger adjusted average core deposit declined, average interest bearing demand deposits increased at a merger adjusted 3% rate with average non-interest-bearing demand deposits increasing at a merger-adjusted 5% annualized rate.

We're also pleased with the broad-based growth in our key fee income categories.

On a merger adjusted basis, mortgage banking increased 13%, service charges on deposit accounts increased 12%, and other service charges and fees also increased 12%.

On the expense side and before operating lease expense, merger adjusted expenses increased 2%.

Half of this increase was in marketing expense and it related to the timing of a television media campaign.

Don will provide the details, but excluding the affects of operating lease accounting and other significant non-run rate items, operating revenues increased 12% from the year ago quarter with expenses up 10%, giving us operating leverage of 2%.

Given that we are expensing stock options for the first time this year, we're especially pleased with this performance.

Six month year-to-date operating leverage was 3.2%, compared to 3.5% for full year 2005.

Underlying credit quality performance was solid and our outlook is for more of the same.

Net charge-offs were 21 basis points, down 18 basis points from last quarter.

Our loan loss reserve ratio was unchanged at 1.09% as provision expense exceeded net charge-offs.

Non-performing loans declined slightly with our loan loss reserve steady, the NPL coverage ratio rose slightly to 213% from 209%.

OREO increased $16.4 million, although 12.6 million represented a reclassification of U.S. government guaranteed foreclosed residential Jennie May mortgages to OREO from the 90 day past due but still accruing category.

The important point is that this reclassification had no impact on the overall risk embedded in our loan portfolio.

Nothing has changed prospectively regarding these loans.

This is really just a balance sheet geography issue.

Lastly our period and tangible common equity ratio was 6.46% down from 6.97% as we repurchased 8.1 million shares during the quarter.

Even so, this ratio is at the upper end of our 6.25 to 6.5% target.

Additional highlights for the quarter are shown on slide 8.

The most significant strategic achievement was the very successful conversion of the 110,000 Unizan consumer and business accounts under the Huntington platforms on April 24th.

This was accomplished in only 55 days after the close, and went very smoothly.

It reflected a lot of hard work in both planning and executing the conversions.

We're confident of our ability to achieve the merger's planned expense synergies and we're already seeing signs of revenue opportunities.

While the management team we have assembled since 2001 has a lot of merger experience individually, this was our first merger as a new team.

Our success gives us confident we're building a core competency in this important area.

Another milestone was the termination of the Federal Reserve formal written supervisory agreement on May 10th.

As noted a moment ago, we repurchased 8.1 million shares of Huntington's stock under our current 15 million share authorization. 6 million shares represented an accelerated share repurchase program executed on May 24th.

In closing, we're very pleased with the first half of the year performance.

Year to date earnings per common share were $0.90.

As such we are narrowing our early year earnings per common share target ratio to $1.80 to $1.83.

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

Thanks, Tom.

As shown on slide 10, reported for GAAP net income was $111.6 million or $0.46 per share, up 5% and 2% respectively from a year ago quarter.

There were two significant items that impacted the quarter's results on a net basis they had no impact on reported earnings per share.

First, there was a $2.3 million pre-tax positive impact from equity investment gains or about $0.01.

Each quarter's results reflect any mark to market gains or losses on equity investments, and we considered such gains or losses as part of our recurring income.

They are highlighted on this slide because they were large enough to impact linked quarter and year-over-year comparisons and trends.

The second item was a $2.6 million pre-tax, or $0.01 per share negative impact related to Unizan merger costs.

These represent current period expenses associated with the merger integration, like staff retention compensation expense and do not represent the run rate amount contributed by Unizan to expenses.

Slide 11 provides a summary of second quarter financial highlights.

Most of these will be covered in more detail in later slides so let's move forward.

Slide 12 shows that net interest income on a fully tax equivalent basis increased $19 million or 8% from the first quarter.

Excluding the $12 million increase related to the Unizan merger, fully taxable equivalent net interest income increased a merger-adjusted $7 million, or 3% on a linked quarter basis.

The chart on the right-hand side of the slide shows the stability of our net interest margin.

As discussed in the past, the reasons for the stability in our net interest margin include over half of our total loans are variable rate.

About one-fourth of our investment securities are also variable rate.

Because of the relatively short duration of our fixed rate assets we are also not as exposed to the flattening at the long end of the yield curve.

We also continue to be disciplined in our loan and deposit pricing strategy.

In support of this last point, I find it quite telling that from this first quarter of 2004 through the second quarter this year, the spread between our loan yields and our deposit rates declined only 1 basis point.

This compares very well to our Midwest peers where some have seen declines of over 40 basis points.

We continue to believe our net interest margin will remain fairly stable going forward.

Slide 13 is the first of three slides we introduced last quarter that are designed to help you understand linked quarter underlying trends in loans and deposits, excluding the impact of the Unizan merger.

Our usual loan and deposit growth slides can be found in the appendix.

Here we adjust the reported numbers to exclude the impact of the Unizan loans since they are in the current quarter for three months versus only one month last quarter.

As such, reported results which are unadjusted for this, overstate growth rates all things being equal.

Obviously beginning with the third quarter results these adjustments will no longer be needed in any link quarter growth analysis.

As shown at the top, average total loans and leases increased at a 20% annualized rate from the first quarter, or 3% on a merger adjusted basis.

A similar analysis shows that reported average total commercial loans grew at an annualized 30% from the 2006 first quarter but 11% on a merger adjusted basis.

Slide 14 performs a similar analysis on our home equity, residential mortgage and auto loan, and lease portfolios.

Merger adjusted home equity loans grew an annualized 3% from the first quarter, reversing the downward trend of prior quarters.

Our slower growth rate reflects a combination of factors, including a decision to decrease our third party origination activity.

While home equity loan production remains lower than historic levels, there was a pick up in production this past quarter.

We also continue to originate high quality loans, with 730 plus FICO scores on originations this past quarter.

Merger adjusted residential mortgages increased an annualized 5%, up from the first quarter.

While the production levels continue to be below 2005 levels, this was a nice pickup representing a 39% increase in closed loan production.

Merger adjusted total average automobile loan and leases declined an annualized 12%.

This decline reflected $218 million of loan sales in the current quarter, a modest gain, as part of our ongoing program of selling a portion of current automobile loan production.

Automobile loan origination volumes increased 13% from the first quarter, and represented one of the strongest origination quarters since the first quarter of 2004.

Automobile direct finance lease-up originations increased as well.

Though the absolute volume of originated leases remained at historic low levels.

We continued to originate automobile loans and leases with an average FICO score in the mid-740 range.

Our exposure to automobile loans and leases continue to drop, from slightly less than 16% at quarter end down from 18% at the end of last year.

Slide 15 performs a similar analysis for core and total deposits.

Merger adjusted average total core deposits declined 1% whereas merger adjusted total average total deposits increased 4%.

Slides 143 through 152 in the appendix detail deposit trends by type of deposit as well as by business segment and by commercial and consumer classification.

The main story is that intense competition continues to make growing deposits a challenge, especially if we maintain discipline to our product pricing.

With most of the deposit activity characterized as the continued movement of savings and other timed deposit balances into retail CDs.

With rates rising, such accounts continue to be the deposit of choice for rate sensitive retail customers.

We were encouraged, however, that on a merger adjusted basis, non-interest bearing and interest-bearing demand deposits increased an annualized 5% and 3% respectively.

We have increased advertising efforts, employing center programs specifically targeted at growing these deposits, and it is encouraging to see that we may be getting some traction.

Slide 16 reviews the non interest income trends.

Looking first two lines just above the total reported line at the bottom.

Operating lease income continues to decline, reflecting the runoff of this portfolio.

On a merger-adjusted basis, non-interest income before operating lease income increased $3.2 million, or 2% from the first quarter and was 19% higher than a year ago.

Slide 78 in the appendix provides a reconciliation to reported results.

Let me talk about the primary items, starting at the top.

Deposit service charge income increased $6 million, or 15%, including $1.1 million merger related.

The increase reflected strength in personal service charges, primarily NSF and OD fees, as well as commercial service charges.

On a merger-adjusted basis, deposit service charge income increased $5 million or 12%.

Other service charges and fees increased $1.6 million, or 14% from the first quarter reflecting higher debit card volumes.

On a merger adjusted basis other service charges and fees increased $1.4 million or 12%.

Trust services income continued its string of 11 consecutive quarterly increases and with $1.4 million, was 7% higher than first quarter reported income.

On a merger adjusted basis, trust services income grew $0.3 million, or 1%, with the increase primarily reflecting higher Huntington fund fees due to 2% growth in managed assets.

Brokerage and insurance revenues were down $0.8 million or 6% from the first quarter reported levels.

The decrease primarily reflected a decline in insurance income, mostly lower revenue net of claims of an automobile insurance-related product.

On a merger-adjusted basis, brokerage and insurance revenues were down $1.2 million or 8%.

Key contributing factors the 14% increase in mortgage banking on the next slide.

Slide 17 provides a complete picture of mortgage banking income and related hedging upon which Unizan had no material impact.

The top half showed the various components of mortgage banking income, with the bottom showing the net impact of MSR valuation adjustments and related hedging, which mostly impact other non-interest income.

Looking first at core mortgage banking income, this totaled $12.1 million in the second quarter, up from recent quarters primarily reflecting higher secondary marketing fees.

Mortgage loan volumes also increased 39% from first quarter levels.

Now looking at the net impact of MSR hedging, the bottom half of the slide, you will see that $8.3 million MSR evaluation adjustment, which is recorded as part of mortgage banking income.

This was partially offset by $6.7 million of hedge-related trading losses which were recorded in other non-interest income.

Slide 18 details trends in non-interest expense.

Shown at the bottom, operating lease expense continued its declined as its portfolio runs off.

Current quarter expense levels included $20.6 million related to the Unizan merger, $18 million of which were merger-related expenses plus $2.6 million of current period merger costs.

This compares with $6.9 million in the first quarter consisting of $5.9 million of merger related expenses plus $1 million of merger costs.

When comparing underlying performance to year-ago quarter, we also exclude the current period expense of $4.3 million related to stock option expensing which began this year.

Taking these into account, adjusted non-interest expense before operating-lease expense increased $4.1 million, or just 2% from the first quarter.

It was also 1% lower than a year ago.

Slide 91 through 97 in the appendix provide the reconciliation to reported results.

In sum we feel very good about our progress in controlling expense growth.

Starting at the top again let me comment only on the significant items.

Personnel costs were $6.3 million, or 5% higher than first quarter with Unizan contributing $5.7 million of this increase.

On a merger adjusted basis therefore, personnel costs increased only $0.7 million or less than 1%.

Marketing expenses increased $3.1 million, or 42% with Unizan contributing only $0.6 million of this increase.

Again, on a merger adjusts basis, therefore, marketing expenses were up $2.5 million or 35%, primarily reflecting upfront and development costs of a stepped-up television commercial campaign.

The $1.9 million in amortization of intangibles was all merger related.

Other expenses totaled $19.7 million.

This was $3.4 million or 21% higher than first quarter.

The Unizan merger accounted for $2.1 million of this increase.

Slide 19 shows the trend in our reported efficiency ratio.

It shows a slight decrease of 58.1% in the first quarter with 58.3% in the prior quarter.

One of our corporate objectives is to generate positive operating leverage by growing revenues faster than expenses.

Slide 20 is an analysis designed to show operating leverage performance after adjusting for the effects of operating lease accounting on revenue and expenses as well as for large items that affect comparability.

Those of you familiar with Huntington know that the operating lease accounting impacts both revenue and expense trends, with the operating trends with no new automobile operating leases originated since April 2002, this portfolio has been in a run-off mode ever since.

As a result, both operating lease income and operating lease expense continued to trend downward.

This lowers both revenue and expense trends, thus distorting underlying revenue and expense growth rates.

Slide 20 with details shown on slides 103 and 104 of the appendix adjust revenue and expenses for operating lease accounting, as well as other large items that affect comparability to determine a more insightful view of operating leverage performance.

Slide 20 shows that compared with a year ago quarter, operating leverage on this adjusted basis was a positive 2%.

This is a very good beginning toward our full year goal of generating positive operating leverage.

Also shown at the slide on the bottom, our efficiency ratios calculate on the same adjusted basis.

Here you can see that our adjusted efficiency ratio in the first quarter was 56.4%, which was less than the reported 58.1% shown on the previous slide.

This compares favorably with a 56.9% on a similarly adjusted basis in the first quarter and 57.4% in the year ago quarter.

Slide 21 details capital trends.

At the end of the second quarter, our tangible equity asset ratio was 6.46%, and our tangible equity risk weighted assets were 7.29%.

These declines from the end of the first quarter were driven by the 8.1 million shares we purchased during this quarter.

There are 6.9 million shares remaining under current authorization levels.

Of the 51 basis point decline on our tangible equity ratio, the share repurchases contributed about 53 basis points, with this being partially offset by the positive impact of retained earnings.

Even with the declines our capital ratios remain strong, with our tangible common equity ratio still near the top end of our 6.25, 6.5% targeted range.

As noted earlier on slide 11, we are generating internal capital at an annualized 7% rate.

So all things being equal, our capital ratios will continue to improve throughout the remainder of this year.

Let me close my session with some comments on credit quality, where underlying performance, as Tom noted, was stable.

As shown on slide 22, our NPA ratio ended the quarter at 65 basis points, and NPAs increased $16.2 million, but as Tom mentioned, $12.6 million of this increase represented a reclassification of U.S. government guaranteed foreclosed loans to OREO from 90 day past due but still accruing loans.

It is important to emphasize that this increase in OREO is simply a reclassification, there has been no change in the underlying risk of our portfolio.

Our net charge-off ratio was 21 basis points, down 18 basis points from the prior quarter and the lowest level in many quarters.

It may be worth mentioning again that the 39 basis points of chargeoffs in the prior quarter reflected $6.5 million related to the resolution of certain loans that were classified as non-performing loans in the 2005 fourth quarter, and for which reserves had previously been established.

As you know, there's been a good deal of media attention given to mortgage and home equity delinquency rates increasing significantly in the Midwest, and in Ohio in particular.

We continue to not see that.

Our 90 day delinquency ratio for home equity loans and lines declined 7 basis points from the first quarter.

And our residential mortgage delinquency ratio dropped by 14 basis points.

The latter reflecting the reclass of OREO -- to OREO of U.S. government guaranteed loans.

In the absence for the reclass, our 90 day delinquencies would have increased slightly, but still would have been around the lowest absolute level we have been at in several years.

There's also been some external speculation regarding the performance of dealer floor plan loans which represents a $623 million portfolio for us.

This portfolio continued to perform well and we have no related NPAs or 30-day delinquencies in this portfolio.

In addition, we have no NPAs or 30 day delinquencies in dealer sales entire $850 million-plus commercial loan portfolio.

Against the backdrop of this strong delinquency performance, we continue to be confident that full year net charge-offs will still be slightly below or at the lower end of our targeted 35 to 45 point basis range.

I'll talk about other items on the following slides: First, some comments on the NPA trends.

Slide 23 illustrates the trend in non-performing assets and I already noted that $12.6 million of the $16.2 million increase from March 31st represented U.S. government guaranteed OREO.

It is worthy to note that 53% of our NPAs represent either US government guaranteed assets, or low-risk residential real estate assets.

The graph on the left-hand side of slide 24 shows the trend in our allowance for loan on lease losses.

At June 30th, allowance for loan lease losses was $287.5 million, up $3.7 million from March 31st.

As expected our period end loan loss reserve ratio remains stable at 1.09%.

On the right-hand side, we show the trends in two loan-loss reserve components, which have also been relatively stable over the last few quarters.

The 1 basis point decline in economic reserve component reflected the net impact resulting from changes in the four economic indicators.

In sum, the benefits from improvements in the manufacturing index and consumer confidence index were slightly offset by declines in non-agricultural employment and personal consumption spending indices.

We expect our loan loss reserve ratio will continue to be relatively stable going forward.

On slide 25 the allowance for unfunded loan commitments is show separately from the total allowance for loan and lease losses at the top of the slide.

You will recall we report the allowance for unfunded loan commitments separately as a liability.

However, both reserves are available to cover credit losses and for analytical purposes we add these two together into a total allowance for credit losses amount, the third line on the slide.

The first set of ratios compares our reported allowance for loan-lease losses prepared in loans and leases to non-performing assets and non-performing loans.

On this adjusted basis, our end reserve ratio, as noted above, was 1.09% and our NPA and NPL coverage ratios were 168% and 213% respectively.

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

On this basis, our period end reserve ratio was 1.24%, also unchanged, with NPA and NPL coverage ratios of 191% and 241% respectively.

As a reminder, the declines in our NPA and NPL coverage ratios for the last couple of quarters have been heavily influenced by the addition of the -- in the 2006 first quarter of SBA guaranteed NPLs associated with the Unizan merger, and the reclassification this quarter of the US government guaranteed OREO assets.

Our NPL and NPA coverage ratios reflect the lower risk profile.

In conclusion, we're very pleased with our overall credit quality performance and reserve adequacies.

We believe that full year credit quality will continue to be strong going forward.

This completes the financial review for this quarter.

Let me turn it back over to Tom.

Thanks, Don.

Turning to slide 27, as you know, when earnings guidance is given, it's our practice to do so on a GAAP basis unless otherwise noted.

Such guidance includes the expected results of all significant forecasted activities.

However, guidance typically excludes unusual or one-time items as well as selected items where the timing and financial impact is uncertain, until such time as the impact can be reasonably forecast.

Regarding performance drivers, we continue to anticipate revenue growth in the low to mid-single digits and expense growth in the low single digit range.

Loan growth is expected to be modest with commercial doing well with more of a challenge in residential mortgages and home equity loans.

We also think our net interest margin will remain fairly steady, around this quarter's level of 3.34%.

We continue to believe that revenues will grow faster than expenses and anticipate positive operating leverage for the full year, and continued improvement in our efficiency ratios.

Regarding credit quality, we continue to anticipate a full year net charge-off ratio to be slightly below or at the lower end of our 35 to 45-basis point targeted range, and relatively stable NPA and allowance for loan loss ratios with those of June 30.

You'll note that we have not assumed additional share repurchases, though as Don noted, we still have 6.9 million shares under the current authorization.

Given our 6 month earnings performance of $0.90 a share, we're narrowing our 2006 full-year GAAP earnings per share guidance to $1.80 to $1.83, inclusive of stock option expense and the current-year Unizan acquisition impact.

This completes our prepared remarks.

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

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

Operator?

[OPERATOR INSTRUCTIONS].

We will pause for just a moment to compile the Q&A roster.

Your first question comes from the line of Kevin Reevey with Ryan Beck.

Good afternoon, guys, how are you?

Hi, Kevin.

I was looking at your average rates on some of your loan categories, and particularly I was surprised that the home equity jumped up 62 basis points in one quarter.

Was that because there was some teaser rates that ended-- I was just-- can you talk a little bit about that?

And then also your small business lending average rate was up 43 basis points link quarter.

Kevin this is Don, and as far as the home equity yields for the quarter, as you might remember in the first quarter, we had an adjustment to true up some accounting for certain loan fees which had a negative impact of about $2.3 million in the home equity loan yields last quarter, and so by reversing-- or by excluding that impact you see more of a normal increase in the overall yield on a link quarter basis in that line item.

As far as the home equity loan-- the small business yield improvements, I think more of that is just tied to the prime rate changes during the time period.

I'm not aware of anything unusual in either of the two quarters that would have triggered any adjustments there.

The reason I ask because a lot of the banks I follow, the increases link would have been more in the 25 to 30-basis point increase.

So you-- you are on the high end there.

Well, we have had a-- a few changes as far as classifications as a result of the Unizan merger, but I don't think it would have a material impact on the yields there.

I think it's more normal business in those categories.

Kevin, Tom here.

Just our continued attempts to be disciplined as to our pricing.

And then, Don, do you expect the marketing expense line item to continue to move up, given the fact-- it sounds like you are still in-- in the marketing, advertising, rebranding phase with the Unizan deal having closed.

We think that the second quarter level of marketing costs are going to be higher than what we would experience for the second half of this year.

We did incur some development and start-up costs associated with some of the campaigns that we launched toward the end of the second quarter and we would expect to see those costs drop from-- from that quarter's levels.

Great.

Thank you.

Thank you, Kevin.

Your next question comes from the line of Bob Hughes with KBW.

Hey, good afternoon, guys.

Hey, Bob.

Question.

Don, could you remind us when you expect the operating leases to be substantially run off?

I think they are down well below $200 million this quarter.

I think by the end of this year we'll see them essentially gone from-- from the balance sheet.

So we-- we're not going to see much of an impact beyond into 2007.

Okay.

Great.

Looking at charge offs it looks like in the middle market area in CNI in construction particularly you have had a lot of recoveries over the past few quarters.

Is there any color or light you have shed on that?

And how do you feel-- as a follow up, Tom, did I understand you correctly that charge-offs for this year could possibly come in below your targeted range? 35 to 45 basis points?

Yes.

Given the performance in the first half, I guess.

That's certainly a possibility, Bob.

Okay.

And Don that or Tim, the -- the credit-- the charge-offs in the middle market arena-- or recoveries, rather?

Yes, this is Tim.

We clearly had some recoveries.

I would call them normal course of business recoveries, if you think about the timing of losses, the level of losses back in early 2000.

There's-- there's nothing specific or dramatic to comment on.

Okay.

And then finally, Tom, have you guys made any announcements about who you expect to fill the treasurer's seat after Mahesh left?

We have not, Bob.

That's something Don and I are giving consideration to.

Don very ably is overseeing that function today.

We haven't reached any conclusion about what direction to go in.

Okay.

Thanks, guys.

Your next question comes from the line of Heather Wolf with Merrill Lynch.

Hi, good afternoon.

Hi, Heather.

Two questions for you first of all on the margin can you tell us what the impact of Unizan was and also what the impact was from any hedging?

I'm sorry from hedging?

Yes.

As far as Unizan it really didn't have much impact to the margin itself.

I think it's less than a couple of basis points total on a mark-to-market basis.

The margin that Unizan has was pretty comparable to our [3.30 - 4] range.

As far as hedging, I don't know that we can segregate out just the impact as far as on our margin from our hedging activity.

We tend not to manage our interest rate risk position to make sure that we're as interest rate neutral as we can possibly get.

I don't know that hedging that portfolio had any specific impact.

If you are talk about the MSR hedging activity, we really didn't have much in the way of on balance sheet assets included in our hedging strategy for this past couple of quarters, more of them have been derivative type contracts that didn't have a net impact on our margins.

Okay.

That's helpful.

Also on the deposit service charges and other service charges have you done any repricing programs there, or are can you tell us why those were so strong versus last quarter?

We have not done any formal repricing of our deposit service charges.

The first quarter tends to be a fairly low quarter for us especially when it relates to some of the personal service charges.

So we did see those recover a little bit.

More of it was-- was just from additional commercial service charge income and a little bit higher NSF and OD fees from our consumers.

Okay.

And then just one last question on credit quality.

You talked a lot about how well you guys are performing relative what press releases indicate, but-- your peers out there are having a little bit more trouble than you are, particularly in the non-performing asset category.

Do you have any views on-- on why your balance sheet isn't under the same strain as some of your competitors -- are?

Heather this is Tom.

As you would know, over the last five years we have worked very hard to make a lot of changes in our credit portfolio.

Reducing substantially the shared national credit component; reducing a lot of the large exposures, getting more granular; reducing the auto portfolio significantly.

Our residential portfolio today is a higher percentage than it had been.

There are lots and lots of changes, and quite frankly, I think those are bearing fruit today.

So it doesn't mean to suggest that others haven't also worked on their particular situations, but we believe very much that we have taken a lot of risk out of this portfolio over the last several years, even within segments like auto.

Our underwriting profile is substantially higher than it had been previously, and we quite frankly and maybe you hear this from everybody we have not stretched a lot on structure in the last couple of years, even in the face of pretty intense competition.

So it doesn't mean that we're not going to have a credit issue here and there going forward, but we feel quite good about the condition of our portfolio overall.

Okay.

Great.

Thanks so much.

Thanks, heather.

Your next question comes from the line of Christopher Chouinard with Morgan Stanley.

Hello, good afternoon, everyone.

Hi, Chris.

I wonder if you could just give a little color around your decision to stop working with third-party originators.

Chris, this is Tom.

We have not stopped.

In some of our markets we still purchase originations from third party brokers, but our reliance on that channel is much, much lower than it used to be.

And a reason for that is we simply found that we had poorer credit quality in that channel.

We also had greater difficulty in ensuring the quality of things like appraisals, and so, we just decided that, particularly at a time when there was maybe a little bit more uncertainty about the economy, that it was better to forsake some growth in order to get more control over the quality side of it, and let me just ask Tim Barber if he wants to add anything to that.

Tim?

I think, Tom, you explained it exactly.

We did not get out of it.

We remain in it.

It's just a little more focused and we spend a lot of time around the credit metrics at this stage with the broker or the third party channel.

Great.

And it is possible to give a little color on the areas where maybe you have pulled back a little bit and where you haven't?

It sounds like there have been a market or two where you might have sort of cut back on this a little more than in other places?

We remain in the business in the markets.

We have some markets that had a higher reliance "on the broker business".

We have communicated that broker represents somewhere in the 20 to 25% range historically.

We'd clearly like to move that down across the franchise, and I think we'll move it across the franchise, so it's not a market specific, although individual markets will be affected more-- some more than others.

Some of the specific things we did the-- the loan to value and the-- the FICO score requirements associated with the third-party channel were adjusted.

Okay.

Great.

Thank you.

Your next question comes from the line of Matthew O'Connor with UBS.

Good afternoon.

Hi, Matt.

Excluding some of the noise from Unizan, I think you mentioned both your non-interest bearing deposits and interest checking were up a little bit.

That's different from what we're seeing at other banks, where we're seeing declines in both categories.

Just wondering if you could give more color in terms of where it's coming from?

Is it on the retail side, commercial, what markets, et cetera?

Chris this is Don and as far as the results there, it has been a concerted effort on our part just to focus on that side of the deposit relationships.

We recognize that our deposit mix isn't as favorable as some of our competitors so we have had increased marketing efforts directed toward raising consumer non-interest bearing and interest bearing transaction accounts as well as some business banking accounts as well.

So I don't know that we have had any particular areas that have stood out as far as growth rates there, or any particular commercial versus consumer results that have-- have really triggered that growth.

It's been more of a consistent story throughout the company.

Okay.

And then just a modeling question here.

The all other fees of 19 million, I know there's a lot of moving pieces to the VC and mortgage hedge there, but is this 19 million a pretty good run rate all in?

We typically wouldn't give guidance as far as individual line items.

That would include the mortgage piece.

It also includes the-- our hedge fund income from our investments, and-- and so absent the noise created from those two items, I think that there aren't unusual items included in that this past quarter.

Okay.

Thanks.

Yes.

[OPERATOR INSTRUCTIONS].

Your next question comes from Greg Cummings with KeyBanc.

Yes.

Good afternoon.

Hey, Fred.

Tom or Don can you give us a quick update on where the cost savings realization stand at Unizan, how you're doing on customer retention, both corporate and on the retail deposit side?

Okay.

Yeah, Fred, this is Don, and as far as the cost-save projections, our projections now would show we're probably a little ahead of schedule compared to what we would have originally assumed.

I think our initial assumption was -- a run rate savings of about $16 million, and we're probably a couple million dollars ahead of that schedule going forward and have been very pleased with that outcome.

Fred, this is Tom.

I think in terms of customer retention we have been well satisfied with that.

I think one of the things that really helped us was being able to execute pretty smoothly the IT conversions, the-- the data conversions, and the Unizan-- former Unizan associates now Huntington team members out in the banking offices, I think felt great support they were able to handle customer questions that inevitably occurred during transition, so that has gone well, and not much attrition on either the consumer or commercial side.

Okay.

Then as a follow-up, Tom, what would your appetite be to pursue another relatively small deal at-- at this time?

Say, small end is defined as say less than 5 billion or-- or so of assets?

Well, I continue to believe, Fred, that what the Midwest needs is intra-Midwest transactions, because of the difficult environment with the yield curve, the lack of consolidation thus far in our region, and the relatively slow growth characteristics of our markets.

And so more should happen.

We-- I think, based upon our success with Unizan, feel very good about participating in that as a buyer, and feel like we have got the capability to do it.

We continue to want to get bigger in each of our existing states as-- as we mentioned in the past.

And we very much look for capable management teams who want to stay with us, given our focus on being an acting local, so we recognize that it always takes a willing seller in addition to a willing buyer, but we would very much be interested in participating.

Okay.

Thanks, Tom.

Thank you.

At this time, there are no further questions.

Okay.

Judy, well at this point--

Excuse me, sir?

Yes.

We do now have a question from Andrew Marquardt with Fox-Pitt Kelton.

Hi, guys just a follow-up question can you talk about expectations in the marketplace?

Has it changed at all despite the fact you are doing okay or better on Unizan thus far and you might feel good about potentially finding something else?

Have some of those expectations changed at all in the last several months or so given kind of the tough environment?

Andrew, this is Tom.

I regret to tell you that I don't think they have changed significantly.

I don't think they are noticeably lower.

What I think needs to happen and the basis of which Huntington would be prepared to participate, is what I would call low-premium deals with reasonably good earnings accretion right from the start in year one and to the degree that expectations are for higher premium deals, I don't think that works in the Midwest.

It might work elsewhere, and I haven't seen-- I haven't seen a lot of lessening in those expectations thus far.

Okay.

Great.

Thanks.

Last question was just a clarification.

On the reserve level commentary earlier, were you saying that the level of absolute reserves will remain fairly stable or the level of reserve coverage?

We were just basically saying that the reserve ratios would remain relatively stable so the 109 allowance, 124 allowance for credit losses would remain around that level for the rest of the year.

Thank you.

There are no further questions at this time.

I will now turn the call back over to closing remarks.

Thank you, Judy.

Thank you everybody for participating on this Friday if you have follow-up calls please call the Investor Relations department.

Have a nice weekend.

This concludes today's conference call.

You may disconnect at this time.