text:
(Mark One)
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2005
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Commission File Number 0-2525
Huntington Bancshares Incorporated
Maryland 31-0724920
incorporation or organization) (I.R.S. Employer Identification No.)
41 S. High Street, Columbus, OH 43287
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (614) 480-8300
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock — Without Par Value
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Exchange Act. T Yes £ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. £ Yes T No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. T Yes £ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. T
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer T Accelerated filer £ Non-accelerated filer £
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) £ Yes T No
The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2005, determined by using a per share closing price of $24.14, as quoted by NASDAQ on that date, was $5,361,409,027. As of January 31, 2006, there were 223,403,135 shares of common stock without par value outstanding.
Documents Incorporated By Reference
Part II of this Form 10-K incorporates by reference certain information from the registrant's Annual Report to shareholders for the period ended December 31, 2005.
Part III of this Form 10-K incorporates by reference certain information from the registrant's definitive Proxy Statement for the 2006 Annual Shareholders' Meeting.
Part I.
Risk Factors 10
Item 1B.
Unresolved Staff Comments 17
Properties 17
Legal Proceedings 17
Submission of Matters to a Vote of Security Holders 17
Part II.
Market for Registrant's Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities 17
Selected Financial Data 18
Management's Discussion and Analysis of Financial Condition and Results of Operations 18
Quantitative and Qualitative Disclosures About Market Risk 18
Financial Statements and Supplementary Data 18
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 18
Controls and Procedures 18
Other Information 19
Part III.
Item 10.
Directors and Executive Officers of the Registrant 19
Executive Compensation 19
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 19
Certain Relationships and Related Transactions 20
Principal Accounting Fees and Services 20
Part IV.
Exhibits and Financial Statement Schedules 20
When we refer to "we," "our," and "us" in this report, we mean Huntington Bancshares Incorporated and our consolidated subsidiaries, unless the context indicates that we refer only to the parent company, Huntington Bancshares Incorporated. When we refer to the "Bank" in this report, we mean The Huntington National Bank, our only bank subsidiary. We refer in this report to relevant sections of our 2005 Annual Report to shareholders. Portions of our 2005 Annual Report to shareholders, including the sections we refer to in this report, are filed as Exhibit 13 to, and are incorporated by reference into, this report.
Item 1: Business
We are a multi-state diversified financial holding company organized under Maryland law in 1966 and headquartered in Columbus, Ohio. Through our subsidiaries, we provide full-service commercial and consumer banking services, mortgage banking services, automobile financing, equipment leasing, investment management, trust services, and brokerage services. We also reinsure private mortgage, credit life and disability insurance, and sell other insurance and financial products and services. The Bank, organized in 1866, is our only bank subsidiary. At December 31, 2005, the Bank had:
165 banking offices in Ohio • 12 banking offices in Kentucky
113 banking offices in Michigan • 5 private banking offices in Florida
26 banking offices in West Virginia • one foreign office in the Cayman Islands
23 banking offices in Indiana • one foreign office in Hong Kong
We conduct certain activities in other states including Arizona, Florida, Georgia, Maryland, Nevada, New Jersey, North Carolina, Pennsylvania, South Carolina and Tennessee. Our foreign banking activities, in total or with any individual country, are not significant. At December 31, 2005, we had 7,602 full-time equivalent employees.
Our lines of business are discussed in our Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report to shareholders, which is incorporated into this report by reference. The financial statement results for each of our lines of business can be found in Note 26 of the Notes to Consolidated Financial Statements in our 2005 Annual Report.
Competition is intense in most of our markets. We compete on price and service with other banks and financial services companies such as savings and loans, credit unions, finance companies, mortgage banking companies, insurance companies, and brokerage firms. Competition could intensify in the future as a result of industry consolidation, the increasing availability of products and services from non-banks, greater technological developments in the industry, and banking reform. For example, financial services reform legislation enacted in 1999 eliminated the long-standing Glass-Steagall Act restrictions on securities activities of bank holding companies and banks. That legislation, among other things, permits securities and insurance firms to engage in banking activities under specified conditions.
As discussed further in Note 23 of the Notes to Consolidated Financial Statements, on March 1, 2005, we announced entering into formal written agreements with our banking regulators, the Federal Reserve Bank of Cleveland and the Office of the Comptroller of the Currency (OCC). On October 6, 2005, we announced that the OCC had lifted its formal written agreement with the Bank. We announced at the same time that our written agreement with the Federal Reserve Bank of Cleveland remained in effect, but we were advised that we were in full compliance with all applicable requirements of the Gramm-Leach-Bliley Act of 1999 including the well-capitalized and well-managed criteria.
As discussed further in Note 22 of the Notes to Consolidated Financial Statements, we announced on June 2, 2005, that we had settled the Securities and Exchange Commission (SEC) formal investigation.
Statements in this report concerning any statutory or regulatory provisions or their impact on us are not intended to be comprehensive and are qualified by reference to such statutory or regulatory provisions and, to the extent applicable, to our formal written agreement with the Federal Reserve Bank of Cleveland.
We are a bank holding company and are qualified as a financial holding company with the Board of Governors of the Federal Reserve System (Federal Reserve). We are subject to examination and supervision by the Federal Reserve pursuant to the Bank Holding Company Act. We are required to file reports and other information regarding our business operations and the business operations of our subsidiaries with the Federal Reserve.
Because we are a public company, we are also subject to regulation by the SEC. On December 15, 2005, the SEC adopted final rules establishing three categories of issuers for the purpose of filing periodic and annual reports. Under the new regulations, we are considered to be a "large accelerated filer" and, as such, must comply with the new SEC accelerated reporting requirements.
The Bank is subject to examination and supervision by the OCC. Its domestic deposits are insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation (FDIC), which also has certain regulatory and supervisory authority over it. Our non-bank subsidiaries are also subject to examination and supervision by the Federal Reserve or, in the case of non-bank subsidiaries of the Bank, by the OCC. Our subsidiaries are also subject to examination by other federal and state agencies, including, in the case of certain securities and investment management activities, regulation by the SEC and the National Association of Securities Dealers.
In addition to the impact of federal and state regulation, the Bank and our non-bank subsidiaries are affected significantly by the actions of the Federal Reserve as it attempts to control the money supply and credit availability in order to influence the economy.
Holding Company Structure
We have one national bank subsidiary and numerous non-bank subsidiaries. Exhibit 21 of this report lists all of our subsidiaries.
The Bank is subject to affiliate transaction restrictions under federal laws, which limit the transfer of funds by a subsidiary bank to its parent or any non-bank subsidiary of its parent, whether in the form of loans, extensions of credit, investments, or asset purchases. Such transfers by a subsidiary bank are limited to:
• 10% of the subsidiary bank's capital and surplus for transfers to its parent corporation or to any individual non-bank subsidiary of the parent, and
• an aggregate of 20% of the subsidiary bank's capital and surplus for transfers to such parent together with all such non-bank subsidiaries of the parent.
Furthermore, such loans and extensions of credit must be secured within specified amounts. In addition, all affiliate transactions must be conducted on terms and under circumstances that are substantially the same as such transactions with unaffiliated entities.
As a matter of policy, the Federal Reserve expects a bank holding company to act as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to support each such subsidiary bank. Under this source of strength doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank. They may charge the bank holding company with engaging in unsafe and unsound practices if they fail to commit resources to such a subsidiary bank. A capital injection may be required at times when the holding company does not have the resources to provide it.
Any loans by a holding company to a subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, the bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the institution's general unsecured creditors, including the holders of its note obligations.
Federal law permits the OCC to order the pro rata assessment of shareholders of a national bank whose capital stock has become impaired, by losses or otherwise, to relieve a deficiency in such national bank's capital stock. This statute also provides for the enforcement of any such pro rata assessment of shareholders of such national bank to cover such impairment of capital stock by sale, to the extent necessary, of the capital stock owned by any assessed shareholder failing to pay the assessment. As the sole shareholder of the Bank, we are subject to such provisions.
Moreover, the claims of a receiver of an insured depository institution for administrative expenses and the claims of holders of deposit liabilities of such an institution are accorded priority over the claims of general unsecured creditors of such an institution, including the holders of the institution's note obligations, in the event of a liquidation or other resolution of such institution. Claims of a receiver for administrative expenses and claims of holders of deposit liabilities of the Bank, including the FDIC as the insurer of such holders, would receive priority over the holders of notes and other senior debt of the Bank in the event of a liquidation or other resolution and over our interests as sole shareholder of the Bank.
In December 2004, the Federal Reserve announced a revision of its bank holding company rating system, effective January 1, 2005, to align the system more closely with current supervisory practices. The revised system:
• emphasizes risk management,
• introduces a framework for analyzing and rating financial factors, and
• provides a framework for assessing and rating the potential impact of non-depository entities of a holding company on its subsidiary depository institution(s).
A composite rating is assigned based on the foregoing three components, but a fourth component is also rated, reflecting generally the assessment of depository institution subsidiaries by their principal regulators. Ratings are made on a scale of 1 to 5 (1 highest) and, like current ratings, are not made public. The new rating system applies to us.
Dividend Restrictions
Dividends from the Bank are the primary source of funds for payment of dividends to our shareholders. In the year ended December 31, 2005, we declared cash dividends to shareholders of $193.8 million. There are, however, statutory limits on the amount of dividends that the Bank can pay to us without regulatory approval.
The Bank may not, without prior regulatory approval, pay a dividend in an amount greater than its undivided profits. In addition, the prior approval of the OCC is required for the payment of a dividend by a national bank if the total of all dividends declared in a calendar year would exceed the total of its net income for the year combined with its retained net income for the two preceding years. At December 31, 2005, the Bank could declare and pay dividends to the parent company of $163.0 million and still be considered "well capitalized." The Bank could declare an additional $230.6 million of dividends without regulatory approval at December 31, 2005, although such dividends would take the Bank below "well capitalized" levels.
If, in the opinion of the applicable regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, such authority may require, after notice and hearing, that such bank cease and desist from such practice. Depending on the financial condition of the bank, the applicable regulatory authority might deem the bank to be engaged in an unsafe or unsound practice if the bank were to pay dividends. The Federal Reserve and the OCC have issued policy statements that provide that insured banks and bank holding companies should generally only pay dividends out of current operating earnings.
During 2005, the FDIC classified the Bank as a "well-capitalized" institution, the highest supervisory subcategory. The Bank, therefore, was not obliged under FDIC assessment practices to pay deposit insurance premiums in 2005, either on its deposits insured by the Bank Insurance Fund or on that portion of its deposits acquired from savings and loan associations and insured by the Savings and Loan Association Insurance Fund. Although not currently subject to FDIC assessments for insurance premiums, the Bank is required to make payments for the servicing of obligations of the Financing Corporation that were issued in connection with the resolution of savings and loan associations, so long as such obligations remain outstanding.
The FDIC may alter its assessment practices in the future if required by developments affecting the resources of the Bank Insurance Fund or the Savings and Loan Association Insurance Fund. In November 2005, the FDIC announced that it expected the Bank Insurance Fund to fall below its statutorily mandated reserve target of 1.25 percent of insured deposits by early 2006. This could cause the FDIC to impose premiums on all Bank Insurance Fund-insured institutions. Assessment practices may also be altered if pending legislative initiatives become law.
The Federal Reserve has issued risk-based capital ratio and leverage ratio guidelines for bank holding companies. The risk-based capital ratio guidelines establish a systematic analytical framework that:
• makes regulatory capital requirements sensitive to differences in risk profiles among banking organizations,
• takes off-balance sheet exposures into explicit account in assessing capital adequacy, and
• minimizes disincentives to holding liquid, low-risk assets.
Under the guidelines and related policies, bank holding companies must maintain capital sufficient to meet both a risk-based asset ratio test and a leverage ratio test on a consolidated basis. The risk-based ratio is determined by allocating assets and specified off-balance sheet commitments into four weighted categories, with higher weighting assigned to categories perceived as representing greater risk. A bank holding company's risk-based ratio represents capital divided by total risk weighted assets. The leverage ratio is core capital divided by total assets adjusted as specified in the guidelines. The Bank is subject to substantially similar capital requirements.
Generally, under the applicable guidelines, a financial institution's capital is divided into two tiers. Institutions that must incorporate market risk exposure into their risk-based capital requirements may also have a third tier of capital in the form of restricted short-term subordinated debt. These tiers are:
• "Tier 1", or core capital, includes common equity, non-cumulative perpetual preferred stock (excluding auction rate issues), and minority interests in equity accounts of consolidated subsidiaries, less both goodwill and, with certain limited exceptions, all other intangible assets. Bank holding companies, however, may include up to a limit of 25% of cumulative preferred stock in their Tier 1 capital.
• "Tier 2", or supplementary capital, includes, among other things, cumulative and limited-life preferred stock, hybrid capital instruments, mandatory convertible securities, qualifying subordinated debt, and the allowance for loan and lease losses, subject to certain limitations.
• "Total capital" is Tier 1 plus Tier 2 capital.
The Federal Reserve and the other federal banking regulators require that all intangible assets, except originated or purchased mortgage servicing rights, non-mortgage servicing assets, and purchased credit card relationships, be deducted from Tier 1 capital. However, the total amount of these items included in a bank holding company's capital cannot exceed 100% of its Tier 1 capital.
Under the risk-based guidelines, financial institutions are required to maintain a risk-based ratio of 8%, with 4% being Tier 1 capital. The appropriate regulatory authority may set higher capital requirements when an institution's circumstances warrant.
Under the leverage guidelines, financial institutions are required to maintain a leverage ratio of at least 3%. The minimum ratio is applicable only to financial institutions that meet certain specified criteria, including excellent asset quality, high liquidity, low interest rate risk exposure, and the highest regulatory rating. Financial institutions not meeting these criteria are required to maintain a minimum Tier 1 leverage ratio of 4%.
Special minimum capital requirements apply to equity investments in nonfinancial companies. The requirements consist of a series of marginal capital charges that increase within a range from 8% to 25% as a financial institution's over-all exposure to equity investments increases as a percentage of its Tier 1 capital.
Failure to meet applicable capital guidelines could subject the financial institution to a variety of enforcement remedies available to the federal regulatory authorities. These include limitations on the ability to pay dividends, the issuance by the regulatory authority of a capital directive to increase capital, and the termination of
deposit insurance by the FDIC. In addition, the financial institution could be subject to the measures described below under "Prompt Corrective Action" as applicable to "under-capitalized" institutions.
The risk-based capital standards of the Federal Reserve, the OCC , and the FDIC specify that evaluations by the banking agencies of a bank's capital adequacy will include an assessment of the exposure to declines in the economic value of the bank's capital due to changes in interest rates. These banking agencies issued a joint policy statement on interest rate risk describing prudent methods for monitoring such risk that rely principally on internal measures of exposure and active oversight of risk management activities by senior management.
The Federal Deposit Insurance Corporation Improvement Act of 1991, known as FDICIA, requires federal banking regulatory authorities to take "prompt corrective action" with respect to depository institutions that do not meet minimum capital requirements. For these purposes, FDICIA establishes five capital tiers: "well-capitalized," "adequately-capitalized," "under-capitalized," "significantly under-capitalized," and "critically under-capitalized."
An institution is deemed to be:
• "well-capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a Tier 1 leverage ratio of 5% or greater and is not subject to a regulatory order, agreement, or directive to meet and maintain a specific capital level for any capital measure;
• "adequately-capitalized" if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and, generally, a Tier 1 leverage ratio of 4% or greater and the institution does not meet the definition of a "well-capitalized" institution;
• "under-capitalized" if it does not meet one or more of the "adequately-capitalized" tests;
• "significantly under-capitalized" if it has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3%, or a Tier 1 leverage ratio that is less than 3%; and
• "critically under-capitalized" if it has a ratio of tangible equity, as defined in the regulations, to total assets that is equal to or less than 2%.
Throughout 2005, our regulatory capital ratios and those of the Bank were in excess of the levels established for "well-capitalized" institutions.
FDICIA generally prohibits a depository institution from making any capital distribution, including payment of a cash dividend or paying any management fee to its holding company, if the depository institution would be "under-capitalized" after such payment. "Under-capitalized" institutions are subject to growth limitations and are required by the appropriate federal banking agency to submit a capital restoration plan. If any depository institution subsidiary of a holding company is required to submit a capital restoration plan, the holding company would be required to provide a limited guarantee regarding compliance with the plan as a condition of approval of such plan.
If an "under-capitalized" institution fails to submit an acceptable plan, it is treated as if it is "significantly under-capitalized." "Significantly undercapitalized" institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become "adequately-capitalized," requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks.
"Critically under-capitalized" institutions may not, beginning 60 days after becoming "critically under-capitalized," make any payment of principal or interest on their subordinated debt. In addition, "critically under-capitalized" institutions are subject to appointment of a receiver or conservator within 90 days of becoming so classified.
Under FDICIA, a depository institution that is not "well-capitalized" is generally prohibited from accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market. As previously stated, the Bank is "well-capitalized" and the FDICIA brokered deposit rule did not adversely affect its ability to accept brokered deposits. The Bank had $3.2 billion of such brokered deposits at December 31, 2005.
Financial Holding Company Status
In order to maintain its status as a financial holding company, a bank holding company's depository subsidiaries must all be both "well capitalized" and "well managed," and must meet their Community Reinvestment Act obligations.
Financial holding company powers relate to "financial activities" that are determined by the Federal Reserve, in coordination with the Secretary of the Treasury, to be financial in nature, incidental to an activity that is financial in nature, or complementary to a financial activity, provided that the complementary activity does not pose a safety and soundness risk. The Gramm-Leach-Bliley Act designates certain activities as financial in nature, including:
• underwriting insurance or annuities;
• providing financial or investment advice;
• underwriting, dealing in, or making markets in securities;
• merchant banking, subject to significant limitations;
• insurance company portfolio investing, subject to significant limitations; and
• any activities previously found by the Federal Reserve to be closely related to banking.
The Gramm-Leach-Bliley Act also authorizes the Federal Reserve, in coordination with the Secretary of the Treasury , to determine that additional activities are financial in nature or incidental to activities that are financial in nature.
We are required by the Bank Holding Company Act to obtain Federal Reserve approval prior to acquiring, directly or indirectly, ownership or control of voting shares of any bank, if, after such acquisition, we would own or control more than 5% of its voting stock. However, as a financial holding company, we may commence any new financial activity, except for the acquisition of a savings association, with notice to the Federal Reserve within 30 days after the commencement of the new financial activity.
The USA Patriot Act of 2001 and its related regulations require insured depository institutions, broker-dealers, and certain other financial institutions to have policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing. The statute and its regulations also provide for information sharing, subject to conditions, between federal law enforcement agencies and financial institutions, as well as among financial institutions, for counter-terrorism purposes. Federal banking regulators are required, when reviewing bank holding company acquisition and bank merger applications, to take into account the effectiveness of the anti-money laundering activities of the applicants.
The U.S. Congress has temporarily renewed the USA Patriot Act and is expected to consider permanent renewal early in 2006.
Customer Privacy and Other Consumer Protections
Pursuant to the Gramm-Leach-Bliley Act, we, like all other financial institutions, are required to:
• provide notice to our customers regarding privacy policies and practices,
• inform our customers regarding the conditions under which their non-public personal information may be disclosed to non-affiliated third parties, and
• give our customers an option to prevent disclosure of such information to non-affiliated third parties.
Under the Fair and Accurate Credit Transactions Act of 2003, our customers may also opt out of information sharing between and among us and our affiliates. We are also subject, in connection with our lending and leasing activities, to numerous federal and state laws aimed at protecting consumers, including the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Equal Credit Opportunity Act, the Truth in Lending Act, and the Fair Credit Reporting Act.
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 imposed new or revised corporate governance, accounting, and reporting requirements on us and all other companies having securities registered with the SEC. In addition to a requirement that chief executive officers and chief financial officers certify financial statements in writing, the statute imposed requirements affecting, among other matters, the composition and activities of audit committees, disclosures relating to corporate insiders and insider transactions, codes of ethics, and the effectiveness of internal controls over financial reporting.
Recent Regulatory Developments
Authority for financial holding companies to engage in real estate brokerage and property management services was proposed by the Treasury Department and the Federal Reserve in 2000, but final regulations implementing the proposal have been subject to a statutory moratorium which was renewed by Congress in late 2005 for an additional year. It is not possible at present to assess when or whether final regulations will come into effect.
The U.S. Congress approved deposit insurance reform at the beginning of February 2006. Under the new program, the BIF and the SAIF will be merged. In addition, the FDIC may from time to time adjust the minimum reserve ratio, currently fixed at 1.25%, within a range between 1.15% percent and 1.50%, and may adopt a risk-based premium system. Certain retirement accounts may receive coverage up to $250,000, and the FDIC may adjust coverage levels for inflation commencing in 2010.
The Basel Committee on Banking Supervision presented its "Basel II" regulatory capital guidelines in July 2004, which would require changes by large internationally-active banks in the way in which their risk-based capital requirements are calculated. Federal banking regulators are considering the extent and timing of application of the guidelines to such large U.S. depository institutions.
On the basis of preliminary regulatory pronouncements, it does not appear that we would meet the asset size criteria to be included among the U.S. banking organizations affected by Basel II. In October 2005, however, U.S. banking regulators issued an advance rulemaking notice that contemplated possible modifications to the "Basel I" risk-based capital framework applicable to domestic banking organizations that would not be affected by Basel II. These possible modifications, which would be designed to avoid future competitive inequalities between Basel I and Basel II organizations and which would likely be applicable to us, include:
• increasing the number of risk-weight categories,
• expanding the use of external ratings for credit risk,
• expanding the range of collateral and guarantors to qualify for a lower risk weight, and
• basing residential mortgage risk ratings on loan-to-value ratios.
The banking regulators indicated an intention to publish proposed rules for implementation of Basel I and Basel II in similar time frames, presumptively during 2006.
Guide 3 Information
Information required by Industry Guide 3 relating to statistical disclosure by bank holding companies is contained in the information incorporated by reference in response to Items 7 and 8 of this report.
We make available free of charge on our internet website, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after those reports have been electronically filed or submitted to the SEC. These filings can be accessed under the "Investor Relations" link found on the homepage of our website at www.huntington.com. These filings are also accessible on the SEC's website at www.sec.gov. The public may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
Item 1A: Risk Factors
Like other financial companies, we are subject to a number of risks, many of which are outside of our direct control, though efforts are made to manage those risks while optimizing returns. Among the risks assumed are: (1) credit risk , which is the risk that loan and lease customers or other counterparties will be unable to perform their contractual obligations, (2) market risk , which is the risk that changes in market rates and prices will adversely affect our financial condition or results of operation, (3) liquidity risk , which is the risk that the parent company and/or the Bank will have insufficient cash or access to cash to meet its operating needs, and (4) operational risk , which is the risk of loss resulting from inadequate or failed internal processes, people and systems, or external events.
In addition to the other information included or incorporated by reference into this report, readers should carefully consider that the following important factors, among others, could materially impact our business, future results of operations, and future cash flows.
(1) Credit Risks:
We extend credit to a variety of customers based on internally set standards and judgment. We manage the credit risk through a program of underwriting standards, the review of certain credit decisions, and an on-going process of assessment of the quality of the credit already extended. Our credit standards and on-going process of credit assessment might not protect us from significant credit losses.
We take credit risk by virtue of making loans and leases, purchasing non-governmental securities, extending loan commitments and letters of credit, and being counterparties to off-balance sheet financial instruments such as interest rate and foreign exchange derivatives.
Our exposure to credit risk is managed through the use of consistent underwriting standards that emphasize "in-market" lending while avoiding highly leveraged transactions as well as excessive industry and other concentrations. Our credit administration function employs risk management techniques to ensure that loans and leases adhere to corporate policy and problem loans and leases are promptly identified. These procedures provide us with the information necessary to implement policy adjustments where necessary, and to take proactive corrective actions.
For further discussion about our management of credit risk, see the "Credit Risk" section of Management's Discussion and Analysis of our 2005 Annual Report.
Our loans, leases, and deposits are focused in five states and adverse economic conditions in those states, in particular, could negatively impact results from operations, cash flows, and financial condition.
Concentration of credit risk can also arise with respect to loans and leases when the borrowers are located in the same geographical region. Our customers with loan and/or deposit balances at December 31, 2005, were located predominantly in Ohio, Michigan, West Virginia, Indiana, and Kentucky. Because of the concentration of loans, leases, and deposits in these states, in the event of adverse economic conditions in these states, we could experience more difficulty in attracting deposits and experience higher rates of loss and delinquency on our loans and leases than if the loans and leases were more geographically diversified. Adverse economic conditions and other factors, such as political or business developments or natural hazards that may affect these states, may reduce demand for credit or fee-based products and could negatively affect real estate and other collateral values, interest rate levels, and the availability of credit to refinance loans at or prior to maturity.
Declines in home values in our markets could adversely impact results from operations.
Like all banks, we are subject to the effects of any economic downturn, and in particular, a significant decline in home values in our markets could have a negative effect on results of operations. At December 31, 2005, we had $4.6 billion of consumer home equity loans and lines with a weighted average loan-to-value ratio for the portfolio of 80%. In addition, at December 31, 2005, we had $4.2 billion in residential real estate loans with a weighted average loan-to-value ratio of 71%. A significant decline in home values could lead to higher charge-offs in event of default in both the consumer home equity loan and residential real estate loan portfolios.
(2) Market Risks:
Changes in interest rates could negatively impact our financial condition and results of operations.
Our results of operations depend substantially on net interest income, which is the difference between interest earned on interest-earning assets (such as investments, loans, and direct financing leases) and interest paid on interest-bearing liabilities (such as deposits and borrowings). Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. Conditions such as inflation, recession, unemployment, money supply, and other factors beyond our control may also affect interest rates. If our interest-earning assets mature or reprice more quickly than interest-bearing liabilities in a declining interest rate environment, net interest income could be adversely impacted. Likewise, if interest-bearing liabilities mature or reprice more quickly than interest-earnings assets in a rising interest rate environment, net interest income could be adversely impacted.
Changes in interest rates also can affect the value of loans and other assets, including retained interests in securitizations, mortgage and non-mortgage servicing rights, and our ability to realize gains on the sale of assets. A portion of our earnings result from transactional income. An example of this type of transactional income is gain on sales of loans and other real estate owned. This type of income can vary significantly from quarter-to-quarter and year-to-year based on a number of different factors, including the interest rate environment. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans and leases may lead to an increase in non-performing assets and a reduction of income recognized, which could have a material, adverse effect on our results of operations and cash flows. For further discussion, see Note 5 of the Notes to Consolidated Financial Statements included in our 2005 Annual Report.
Although fluctuations in market interest rates are neither completely predictable nor controllable, our Market Risk Committee (MRC) meets periodically to monitor our interest rate sensitivity position and oversee our financial risk management by establishing policies and operating limits. For further discussion, see the "Interest Rate Risk" section of Management's Discussion and Analysis of our 2005 Annual Report.
We could experience losses on residual values related to our automobile lease portfolio.
Inherently, automobile lease portfolios are subject to residual risk, which arises when the market price of the leased vehicle at the end of the lease term is below the estimated residual value at the time the lease is originated. This situation arises due to a decline in used car market values. A reduction in the expected proceeds from the residual values of our direct financing leases would result in an immediate recognition of impairment on the lease whereas a reduction in the expected proceeds from the residual values of our operating leases would result in an increase in the depreciation of our operating lease assets over the remaining term of the lease. For further discussion about our management of lease residual risk, see the "Lease Residual Risk" section of Management's Discussion and Analysis of our 2005 Annual Report.
(3) Liquidity Risks:
If we are unable to borrow funds through access to capital markets, we may not be able to meet the cash flow requirements of our depositors and borrowers, or meet the operating cash needs to fund corporate expansion and other activities.
Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. The liquidity of the Bank is used to make loans and leases and to repay deposit liabilities as they become due or are demanded by customers. Liquidity policies and limits are established by the board of directors, with operating limits set by MRC, based upon the ratio of loans to deposits and percentage of assets funded with non-core or wholesale funding. The Bank's MRC regularly monitors the overall liquidity position of the Bank and the parent company to ensure that various alternative strategies exist to cover unanticipated events that could affect liquidity. MRC also establishes policies and monitors guidelines to diversify the Bank's wholesale funding sources to avoid concentrations in any one market source. Wholesale funding sources include Federal funds purchased, securities sold under repurchase agreements, non-core deposits, and medium- and long-term debt, which includes a domestic bank note program and a Euronote program. The Bank is also a member of certain Federal Home Loan Banks (FHLB), which provide funding through advances to members that are collateralized with mortgage-related assets.
We maintain a portfolio of securities that can be used as a secondary source of liquidity. There are other sources of liquidity available to us should they be needed. These sources include the sale or securitization of loans, the ability to acquire additional national market, non-core deposits, the issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities, and the issuance of preferred or common securities in public or private transactions. The Bank also can borrow through the Federal Reserve's discount window.
If we were unable to access any of these funding sources when needed, we might be unable to meet customers' needs, which could adversely impact our financial condition, results of operations, cash flows, and level of regulatory-qualifying capital. For further discussion, see the "Liquidity Risk" section of Management's Discussion and Analysis of our 2005 Annual Report.
If our credit ratings were downgraded, the ability to access funding sources may be negatively impacted or eliminated, and our liquidity and the market price of our common stock could be adversely impacted.
Credit ratings by the three major credit rating agencies are an important component of our liquidity profile. Among other factors, the credit ratings are based on the financial strength, credit quality and concentrations in the loan portfolio, the level and volatility of earnings, capital adequacy, the quality of Management, the liquidity of the balance sheet, the availability of a significant base of core retail and commercial deposits, and the ability to access a broad array of wholesale funding sources. Adverse changes in these factors could result in a negative change in credit ratings and impact not only the ability to raise funds in the capital markets, but also the cost of these funds. In addition, certain financial on- and off-balance sheet arrangements contain credit rating triggers that could increase funding needs should a negative rating change occur. Letter of credit commitments for marketable securities, interest rate swap collateral agreements, and certain asset securitization transactions contain credit rating provisions.
Credit ratings as of December 31, 2005, for the parent company and the Bank can be found in Table 26 of Management's Discussion and Analysis of our 2005 Annual Report.
We rely on certain funding sources such as large corporate deposits, public fund deposits, federal funds, Euro deposits, FHLB advances, and bank notes. Although not contractually tied to credit ratings, our ability to access these funding sources may be impacted by negative changes in credit ratings. In the case of public funds or FHLB advances, a credit downgrade may also trigger a requirement that we pledge additional collateral against outstanding borrowings. Credit rating downgrades could result in a loss of equity investor confidence.
We have authorized the use of a substantial amount of our cash for the repurchase of our shares, and this use of funds may limit our ability to complete other transactions or to pursue other business initiatives.
In October 2005, our board of directors authorized a new program for the repurchase of up to 15 million shares. We expect to repurchase shares for cash as business conditions warrant. The full implementation of this repurchase program will use a significant portion of our capital reserves. This use of capital could limit future flexibility to complete acquisitions of businesses or technology, or other transactions, or make investments in research and development, new employee hiring, or other aspects of operations that might be in our best interests, or could require that we borrow money or issue additional equity securities for such purposes. Any incurrence of debt may not be on favorable terms and could result in our being subject to covenants or other contractual restrictions that limit the ability to take advantage of other opportunities that may arise. Any such incurrence of debt would likely increase our interest expense, and any issuance of additional equity securities would dilute the stock ownership of existing shareholders.
(4) Operational Risks:
We have significant competition in both attracting and retaining deposits and in originating loans and leases.
Competition is intense in most of our markets. We compete on price and service with other banks and financial services companies such as savings and loans, credit unions, finance companies, mortgage banking companies, insurance companies and brokerage firms. Competition could intensify in the future as a result of industry consolidation, the increasing availability of products and services from non-banks, greater technological developments in the industry, and banking reform.
In the normal course of business, we process large volumes of transactions. However, there can be no assurance that we will be able to continue processing at the same or higher levels of transactions. If systems of internal control should fail to work as expected, if systems are used in an unauthorized manner, or if employees subvert the system of internal controls, significant losses could result.
We process large volumes of transactions on a daily basis and are exposed to numerous types of operational risk. Operational risk resulting from inadequate or failed internal processes, people, and systems includes the risk of fraud by persons inside or outside the company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control system and compliance requirements. This risk of loss also includes the potential legal actions that could arise as a result of the operational deficiency or as a result of noncompliance with applicable regulatory standards.
We establish and maintain systems of internal operational controls that provide us with timely and accurate information about our level of operational risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost-effective levels. Procedures exist that are designed to ensure that policies relating to conduct, ethics, and business practices are followed. From time to time, losses from operational risk may occur, including the effects of operational errors. Such losses are recorded as non-interest expense.
While we continually monitor and improve the system of internal controls, data processing systems, and corporate-wide processes and procedures, there can be no assurance that future losses will not occur.
Our acquisitions may not receive the necessary approvals, meet income and/or cost saving expectation levels, or be integrated within time frames originally anticipated. We may encounter unforeseen difficulties, including unanticipated integration problems and business disruption in connection with acquisitions. Acquisitions could also dilute stockholder value and adversely affect operating results.
The completion of any merger is dependent on, among other things, receipt of shareholder and regulatory approvals, the timing of which cannot be predicted with precision or may not be received at all. Additionally, a merger may be more expensive to complete than anticipated, as a result of unexpected factors or events, and the anticipated cost savings of a merger may take longer to be realized or may not be entirely achieved. The integration of acquired businesses and operations, including systems conversions, may take longer than anticipated, may be more costly than anticipated and may have unanticipated adverse results relating to our existing businesses or the businesses acquired. Further, decisions to sell or close units or otherwise change the business mix may adversely impact combined results. Moreover, we may be unable to identify, negotiate, or finance future acquisitions successfully. Future acquisitions could result in potentially dilutive issuances of equity securities or the incurrence of debt, contingent liabilities, or amortization expenses.
An extended disruption of vital infrastructure could negatively impact our business, results of operations, and financial condition.
Our operations depend upon, among other things, our infrastructure, including equipment and facilities. Extended disruption of vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking or viruses, terrorist activity or the domestic and foreign response to such activity, or other events outside of our control could have a material adverse impact on the financial services industry as a whole and on our business, results of operations, cash flows, and financial condition in particular. Our business recovery plan may not work as intended or may not prevent significant interruptions of our operations.
New or changes in existing tax, accounting, and regulatory rules and interpretations could significantly impact strategic initiatives, results of operations, cash flows, and financial condition.
The financial services industry is extensively regulated. Federal and state banking regulations are designed primarily to protect the deposit insurance funds and consumers, not to benefit a financial company's shareholders. These regulations may sometimes impose significant limitations on operations. The significant federal and state banking regulations that affect us are described in this report under the heading "Regulatory Matters." These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. These laws, regulations, rules, standards, policies, and interpretations are constantly evolving and may change significantly over time.
In addition, we may be subject to actions of our regulators that are specific to us. For further discussion, see Note 23 of the Notes to Consolidated Financial Statements included in our 2005 Annual Report.
Events that may not have a direct impact on us, such as the bankruptcy of major U.S. companies, have resulted in legislators, regulators, and authoritative bodies, such as the Financial Accounting Standards Board, the SEC, the Public Company Accounting Oversight Board, and various taxing authorities responding by adopting and/or proposing substantive revisions to laws, regulations, rules, standards, policies, and interpretations. International capital standards developed in the framework of the Basel Committee on Banking Supervision may also affect the competitive environment for United States banks.
The nature, extent, and timing of the adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations, or specific actions of regulators, may have a material impact on our business and results of operations; however, it is impossible to predict at this time the extent of any impact from these items.
Non-compliance with USA Patriot Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions.
The USA Patriot and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury Department's Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the last year, several banking institutions have received large fines for non-compliance with these laws and regulations. We have developed policies and procedures designed to assist in compliance with these laws and regulations.
The OCC may impose dividend payment and other restrictions on the Bank, which would impact our ability to pay dividends to shareholders or repurchase stock.
The OCC is the primary regulatory agency that examines the Bank, its subsidiaries, and their respective activities. Under certain circumstances, including any determination that the activities of the Bank or its subsidiaries constitute an unsafe and unsound banking practice, the OCC has the authority by statute to restrict the Bank's ability to transfer assets, make shareholder distributions, and redeem preferred securities.
Under applicable statutes and regulations, dividends by a national bank may be paid out of current or retained net profits, but a national bank is prohibited from declaring a cash dividend on shares of its common stock out of net profits until the surplus fund equals the amount of capital stock or, if the surplus fund does not equal the amount of capital stock, until certain amounts from net profits are transferred to the surplus fund. Moreover, the prior approval of the OCC is required for the payment of a dividend if the total of all dividends declared by a national bank in any calendar year would exceed the total of its net profits for the year combined with its net profits for the two preceding years, less any required transfers to surplus or a fund for the retirement of any preferred securities.
Payment of dividends could also be subject to regulatory limitations if the Bank became "under-capitalized" for purposes of the OCC "prompt corrective action" regulations. "Under-capitalized" is currently defined as having a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0%, or a core capital, or leverage, ratio of less than 4.0%. If the Bank were unable to pay dividends to the parent company, it would impact our ability to pay dividends to shareholders or repurchase stock. Throughout 2005, the Bank was in compliance with all regulatory capital requirements and considered to be "well-capitalized."
For further discussion, see the "Parent Company Liquidity" section of Management's Discussion and Analysis of our 2005 Annual Report.
The Federal Reserve Board may require us to commit capital resources to support the Bank.
The Federal Reserve, which examines us and our non-bank subsidiaries, has a policy stating that a bank holding company is expected to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank. Under the source of strength doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank, and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to such a subsidiary bank. A capital injection may be required at times when the holding company may not have the resources to provide it, and therefore may be required to borrow the funds. Any loans by a holding company to its subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company's bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, the bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the institution's general unsecured creditors, including the holders of its note obligations. Thus, any borrowing that must be done by the holding company in order to make the required capital injection becomes more difficult and expensive and will adversely impact the holding company's results of operations and cash flows.
If any of our Real Estate Investment Trust (REIT) affiliates fail to qualify as a REIT, we may be subject to a higher consolidated effective tax rate.
Huntington Preferred Capital, Inc. (HPCI), Huntington Preferred Capital II, Inc. (HPC-II) and Huntington Capital Financing, LLC (HCF) operate as REITs for federal income tax purposes. HPCI, HPC-II, and HCF are consolidated holding company subsidiaries established to acquire, hold, and manage mortgage assets and other authorized investments to generate net income for distribution to their shareholders.
Qualification as a REIT involves application of specific provisions of the Internal Revenue Code relating to various asset tests. A REIT must satisfy six asset tests quarterly: (1) 75% of the value of the REIT's total assets must consist of real estate assets, cash and cash items, and government securities; (2) not more than 25% of the value of the REIT's total assets may consist of securities, other than those includible under the 75% test; (3) not more than 5% of the value of its total assets may consist of securities of any one issuer, other than those securities includible under the 75% test or securities of taxable REIT subsidiaries; (4) not more than 10% of the outstanding voting power of any one issuer may be held, other than those securities includible under the 75% test or securities of taxable REIT subsidiaries; (5) not more than 10% of the total value of the outstanding securities of any one issuer may be held, other than those securities includible under the 75% test or securities of taxable REIT subsidiaries; and (6) a REIT cannot own securities in one or more taxable REIT subsidiaries which comprise more than 20% of its total assets. At December 31, 2005, HPCI, HPC-II, and HCF met all of the quarterly asset tests.
Also, a REIT must annually satisfy two gross income tests: (1) 75% of its gross income must be from qualifying income closely connected with real estate activities; and (2) 95% of its gross income must be derived from sources qualifying for the 75% test plus dividends, interest, and gains from the sale of securities. In addition, a REIT must distribute 90% of the REIT's taxable income for the taxable year, excluding any net capital gains, to maintain its non-taxable status for federal income tax purposes. For 2005, HPCI, HPC-II, and HCF had met all annual income and distribution tests.
If any of these REIT affiliates fail to meet any of the required provisions for REITs, they could no longer qualify as a REIT and the resulting tax consequences would increase our effective tax rate.
We could be held responsible for environmental liabilities of properties acquired through foreclosure of loans secured by real estate.
In the event we foreclose on a defaulted commercial mortgage and/or residential mortgage loan to recover our investment, we may be subject to environmental liabilities in connection with the underlying real property, which could exceed the value of the real property. Although we exercise due diligence to discover potential environmental liabilities prior to acquiring any property through foreclosure, hazardous substances or wastes, contaminants, pollutants, or their sources may be discovered on properties during our ownership or after a sale to a third party. There can be no assurance that we would not incur full recourse liability for the entire cost of any removal and clean-up on an acquired property, that the cost of removal and clean-up would not exceed the value of the property, or that we could recover any of the costs from any third party.
We have a pending formal supervisory agreement with the Federal Reserve Bank of Cleveland.
On March 1, 2005, we announced entering into a formal written agreement with the Federal Reserve Bank of Cleveland (FRBC) providing for a comprehensive action plan designed to enhance our corporate governance, internal audit, risk management, accounting policies and procedures, and financial and regulatory reporting. The agreement called for independent third-party reviews, as well as the submission of written plans and progress reports by Management and remains in effect until terminated by the banking regulators.
We were verbally advised that we were in full compliance with the financial holding company and financial subsidiary requirements under the Gramm-Leach-Bliley Act (GLB Act). This notification reflects that we and the Bank meet both the "well-capitalized" and "well-managed" criteria under the GLB Act. We believe that the changes we have already made, and are in the process of making, will address the FRBC issues fully and comprehensively.
Item 1B: Unresolved Staff Comments
Item 2: Properties
Our headquarters, as well as the Bank's, are located in the Huntington Center, a thirty-seven-story office building located in Columbus, Ohio. Of the building's total office space available, we lease approximately 39%. The lease term expires in 2015, with nine five-year renewal options for up to 45 years but with no purchase option. The Bank has an indirect minority equity interest of 18.4% in the building. Our other major properties consist of a thirteen-story and a twelve-story office building, both of which are located adjacent to the Huntington Center; a twenty-one story office building, known as the Huntington Building, located in Cleveland, Ohio; an eighteen-story office building in Charleston, West Virginia; a three-story office building located in Holland, Michigan; a Business Service Center in Columbus, Ohio; The Huntington Mortgage Group's building, located in the greater Columbus area; an office complex located in Troy, Michigan; and two data processing and operations centers located in Ohio. The office buildings above serve as regional administrative offices occupied predominantly by our Regional Banking and Private Financial and Capital Markets Group lines of business. The Dealer Sales line of business is primarily located in a three-story office building located in Columbus, Ohio. Of these properties, we own the thirteen-story and twelve-story office buildings, and the Business Service Center. All of the other major properties are held under long-term leases. In 1998, we entered into a sale/leaseback agreement that included the sale of 51 of our locations. The transaction included a mix of branch banking offices, regional offices, and operational facilities, including certain properties described above, which we will continue to operate under a long-term lease.
Item 3: Legal Proceedings
Information required by this item is set forth in Notes 22 and 23 of Notes to Consolidated Financial Statements included in our 2005 Annual Report.
Item 4: Submission of Matters to a Vote of Security Holders
Item 5: Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
The common stock of Huntington Bancshares Incorporated is traded on the NASDAQ Stock Market under the symbol "HBAN". The stock is listed as "HuntgBcshr" or "HuntBanc" in most newspapers. As of January 31, 2006, we had 25,374 shareholders of record.
Information regarding the high and low sale prices of our common stock and cash dividends declared on such shares, as required by this item, is set forth in Table 36 entitled "Quarterly Stock Summary, Key Ratios and Statistics, and Capital Data" included in our 2005 Annual Report. Information regarding restrictions on dividends, as required by this item, is set forth in Item 1 "Business-Regulatory Matters-Dividend Restrictions" and in Note 23 of the Notes to Consolidated Financial Statements included in our 2005 Annual Report.
On January 7, 2005, we released from escrow 86,118 shares of unregistered Huntington common stock, without par value, to three former employees (the "Former Employees") in connection with a settlement upon termination of their employment. In exchange, the Former Employees agreed to waive all claims they may have against us. The shares were initially placed into escrow in connection with our acquisition of LeaseNet, Inc. ("LeaseNet") on September 19, 2002. The Former Employees were the sole shareholders of LeaseNet at the time of this acquisition. The release of these shares in this transaction was deemed to be exempt from registration under the Securities Act of 1933, as amended, in reliance on Section 4(2) since this was a transaction by an issuer not involving a public offering.
Total Total Number of Shares Maximum Number of
Number of Average Purchased as Part of Shares that May Yet Be
Shares Price Paid Publicly Announced Purchased Under the
Period Purchased Per Share Plansor Programs (1) Plans or Programs (1)
October 1, 2005 to October 31, 2005
900,000 $ 22.59 900,000 14,100,000
November 1, 2005 to November 30, 2005
2,775,000 23.92 3,675,000 11,325,000
December 1, 2005 to December 31, 2005
1,500,000 24.18 5,175,000 9,825,000
5,175,000 $ 23.76 5,175,000 9,825,000
(1) Information is as of the end of the period. On October 18, 2005, we announced that the board of directors authorized a new program for the repurchase of up to 15 million shares of our common stock (the 2005 Repurchase Program). The 2005 Repurchase Program does not have an expiration date. The 2004 Repurchase Program, with 3.1 million shares remaining, was cancelled and replaced by the 2005 Repurchase Program. During the fourth quarter, we repurchased 5.2 million shares under the 2005 Repurchase Program. We expect to repurchase the remaining shares from time to time in the open market or through privately negotiated transactions depending on market conditions.
Item 6: Selected Financial Data
Information required by this item is set forth in Table 1 included in our 2005 Annual Report.
Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations
Information required by this item is set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our 2005 Annual Report.
Item 7a: Quantitative and Qualitative Disclosures About Market Risk
Information required by this item is set forth in the caption "Market Risk" included in our 2005 Annual Report.
Item 8: Financial Statements and Supplementary Data
Information required by this item is set forth in the Report of Independent Registered Public Accounting Firm, Consolidated Financial Statements and Notes, and Selected Quarterly Income Statements included in our 2005 Annual Report.
Item 9: Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
Item 9A: Controls and Procedures
Disclosure Controls and Procedures
Our Management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, disclosure controls and procedures were effective.
Internal Controls Over Financial Reporting
Information required by this item is set forth in "Report of Management" and "Report of Independent Registered Public Accounting Firm" included in our 2005 Annual Report.
Changes in Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended December 31, 2005 to which this report relates that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
Item 9B: Other Information.
We refer in Part III of this report to relevant sections of our 2006 Proxy Statement, which we expect to file with the SEC on or about March 9, 2006. Portions of our 2006 Proxy Statement, including the sections we refer to in this report, are incorporated by reference into this report.
Item 10: Directors and Executive Officers of The Registrant
Information required by this item is set forth under the captions "Election of Directors", "Corporate Governance", "Executive Officers of Huntington", "Board Committees", "Report of the Audit Committee", "Involvement in Certain Legal Proceedings" and "Section 16(a) Beneficial Ownership Reporting Compliance" of our 2006 Proxy Statement.
Item 11: Executive Compensation
Information required by this item is set forth under the captions "Executive Compensation" and "Director Compensation" of our 2006 Proxy Statement.
Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Equity Compensation Plan Information
remaining available
Number of for future issuance
securities to be under equity
issued upon Weighted-average compensation plans
exercise of exercise price of (excluding
outstanding outstanding securities
options, warrants, options, warrants, reflected in column
and rights and rights (a))
Plan category (a) (b) (c)
Equity compensation plans approved by security holders
18,767,650 $ 21.32 5,698,420
Equity compensation not approved by security holders (1) (2)
2,236,931 19.32 —
(1) On September 4, 2001, options on 3.2 million shares of common stock were granted to, with certain specified exceptions, full- and part-time employees under the Huntington Bancshares Incorporated Employee Stock Incentive Plan (the Incentive Plan). Under the terms of the Incentive Plan, these options were to vest on the earlier of September 4, 2006, or at such time as the closing price for our common stock for five consecutive trading days reached or exceeded $25.00. Our common stock closing price exceeded $25.00 for each of the five consecutive trading days beginning October 1, 2004, and ending October 7, 2004. As a result, options for 2.0 million shares of common stock granted under the Incentive Plan, net of options for 1.2 million shares cancelled due to employee attrition, became fully vested and exercisable after the close of trading on October 7, 2004. At December 31, 2005, options on 0.7 million shares remain outstanding under this plan.
(2) On August 27, 2002, options on 2.4 million shares of common stock were granted to, with certain specified exceptions, full- and part-time employees under the Incentive Plan. Under the terms of the Incentive Plan, these
options were to vest on the earlier of August 27, 2007, or at such time as the closing price for our common stock for five consecutive trading days reached or exceeded $27.00. At December 31, 2005, options on 1.5 million shares remain outstanding under this plan.
The other information required by this item is set forth under the caption "Ownership of Voting Stock" of our 2006 Proxy Statement.
Item 13: Certain Relationships and Related Transactions
Information required by this item is set forth under the caption "Transactions With Directors and Executive Officers" of our 2006 Proxy Statement.
Item 14: Principal Accounting Fees and Services
Information required by this item is set forth under the caption "Proposal to Ratify the Appointment of Independent Registered Public Accounting Firm" of our 2006 Proxy Statement.
Item 15: Exhibits, Financial Statement Schedules
(a) The following documents are filed as part of this report:
(1) The report of independent registered public accounting firm and consolidated financial statements appearing in our 2005 Annual Report on the pages indicated below are incorporated by reference in Item 8.
Report Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2005 and 2004
Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Changes in Shareholders Equity For the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003
Notes to Consolidated Financial Statements
103 -- 138
(2) We are not filing separately financial statement schedules because of the absence of conditions under which they are required or because the required information is included in the consolidated financial statements or the related notes.
(3) The exhibits required by this item are listed in the Exhibit Index of this Form 10-K. The management contracts and compensation plans or arrangements required to be filed as exhibits to this Form 10-K are listed as Exhibits 10(a) through 10(v) in the Exhibit Index.
(b) The exhibits to this Form 10-K begin on page 22 of this report.
(c) See Item 15(a)(2) above.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 23rd day of February 2006.
(Registrant)
/s/ Thomas E. Hoaglin By: /s/ Donald R. Kimble
Thomas E. Hoaglin Donald R. Kimble
Chairman, President, Chief Executive Chief Financial Officer and Controller
Officer, and Director (Principal Executive (Principal Financial and Accounting Officer)
Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 23rd day of February, 2006.
Raymond J. Biggs *
David L. Porteous *
Raymond J. Biggs
David L. Porteous
Don M. Casto III *
Kathleen H. Ransier *
Don M. Casto III Director
Kathleen H. Ransier Director
Michael J. Endres *
Michael J. Endres
Robert H. Schottenstein
Karen A. Holbrook *
Karen A. Holbrook
John B. Gerlach, Jr. *
John B. Gerlach, Jr.
David P. Lauer *
David P. Lauer
Wm. J. Lhota *
Wm. J. Lhota
* /s/ Donald R. Kimble
Donald R. Kimble
Attorney-in-fact for each of the persons indicated
This report incorporates by reference the documents listed below that we have previously filed with the SEC. The SEC allows us to incorporate by reference information in this document. The information incorporated by reference is considered to be a part of this document, except for any information that is superseded by information that is included directly in this document.
This information may be read and copied at the Public Reference Room of the SEC at 100 F Street N.E., Washington, D.C. 20549. The SEC also maintains an internet world-wide web site that contains reports, proxy statements, and other information about issuers, like us, who file electronically with the SEC. The address of the site is http://www.sec.gov . The reports and other information filed by us with the SEC are also available at our internet world-wide web site. The address of the site is http://www.huntington.com . Except as specifically incorporated by reference into this Annual Report on Form 10-K, information on those web sites is not part of this proxy statement/prospectus. You also should be able to inspect reports, proxy statements, and other information about us at the offices of the NASDAQ National Market at 33 Whitehall Street, New York, New York.
2.(a).
Agreement and Plan of Merger, dated January 27, 2004, by and between Unizan Financial Corp. and Huntington
Bancshares Incorporated -- previously filed as Exhibit 2 to Annual Report on Form 10-K for the year ended December
31, 2003, and incorporated herein by reference.
(b).
Amendment No. 1 to the Agreement and Plan of Merger, dated November 12, 2004, by and between Unizan Financial Corp.
and Huntington Bancshares Incorporated -- previously filed as Exhibit 99.1 to Current Report on Form 8-K dated
November 12, 2004, and incorporated herein by reference.
3(i)(a).
Articles of Restatement of Charter, Articles of Amendment to Articles of Restatement of Charter, and Articles
Supplementary -- previously filed as Exhibit 3(i) to Annual Report on Form 10-K for the year ended December 31,
1993, and incorporated herein by reference.
(i)(b).
Articles of Amendment to Articles of Restatement of Charter -- previously filed as Exhibit 3(i)(c) to Quarterly
Report on Form 10-Q for the quarter ended March 31, 1998, and incorporated herein by reference.
(ii).
Amended and Restated Bylaws as of July 16, 2002 -- previously filed as Exhibit 3(ii) to Quarterly Report on Form
10-Q for the quarter ended June 30, 2003, and incorporated herein by reference.
Instruments defining the Rights of Security Holders -- reference is made to Articles Fifth, Eighth, and Tenth of
Articles of Restatement of Charter, as amended and supplemented. Instruments defining the rights of holders of
long-term debt will be furnished to the Securities and Exchange Commission upon request.
Material contracts:
(a).
* Form of Executive Agreement for certain executive officers -- previously filed as Exhibit 99.1 to Current
Report on Form 8-K dated November 21, 2005, and incorporated herein by reference.
(c).
(d).
* Huntington Bancshares Incorporated Management Incentive Plan, as amended and restated effective for plan years
beginning on or after January 1, 2004 -- previously filed as Exhibit 10(a) to Quarterly Report on Form 10-Q for the
quarter ended June 30, 2004, and incorporated herein by reference.
(e).
* Restated Huntington Supplemental Retirement Income Plan -- previously filed as Exhibit 10(n) to Annual Report on
Form 10-K for the year ended December 31, 1999, and incorporated herein by reference.
(f).
* Deferred Compensation Plan and Trust for Directors -- reference is made to Exhibit 4(a) of Post-Effective Amendment
No. 2 to Registration Statement on Form S-8, Registration No. 33-10546, filed with the Securities and Exchange
Commission on January 28, 1991, and incorporated herein by reference.
(g)(1).
* Deferred Compensation Plan and Trust for Huntington Bancshares Incorporated Directors -- reference is made to
Exhibit 4(a) of Registration Statement on Form S-8, Registration No. 33-41774, filed with the Securities and
Exchange Commission on July 19, 1991, and incorporated herein by reference.
* First Amendment to Huntington Bancshares Incorporated Deferred Compensation Plan and Trust for Huntington Bancshares
Incorporated Directors -- previously filed as Exhibit 10(q) to Quarterly Report 10-Q for the quarter ended March 31,
(h).
* Executive Deferred Compensation Plan, as amended and restated on February 18, 2004 -- previously filed as Exhibit
10(c) to Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, and incorporated herein by reference.
(i)(1).
* The Huntington Supplemental Stock Purchase and Tax Savings Plan and Trust (as amended and restated as of February 9,
1990) -- previously filed as Exhibit 4(a) to Registration Statement on Form S-8, Registration No. 33-44208, filed
with the Securities and Exchange Commission on November 26, 1991, and incorporated herein by reference.
* First Amendment to The Huntington Supplemental Stock Purchase and Tax Savings Plan and Trust Plan -- previously
filed as Exhibit 10(o)(2) to Annual Report on Form 10-K for the year ended December 31, 1997, and incorporated
herein by reference.
(j)(1).
* 1990 Stock Option Plan -- reference is made to Exhibit 4(a) of Registration Statement on Form S-8, Registration No.
33-37373, filed with the Securities and Exchange Commission on October 18, 1990, and incorporated herein by
reference.
* First Amendment to Huntington Bancshares Incorporated 1990 Stock Option Plan -- previously filed as Exhibit 10(q)(2)
to Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference.
* Second Amendment to Huntington Bancshares Incorporated 1990 Stock Option Plan -- previously filed as Exhibit
10(n)(3) to Annual Report on Form 10-K for the year ended December 31, 1996, and incorporated herein by reference.
* Third Amendment to Huntington Bancshares Incorporated 1990 Stock Option Plan -- previously filed as Exhibit 10(b) to
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by reference.
* Fourth Amendment to Huntington Bancshares Incorporated 1990 Stock Option Plan -- previously filed as Exhibit 10(a)
to Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, and incorporated herein by reference.
* Fifth Amendment to Huntington Bancshares Incorporated 1990 Stock Option Plan -- previously filed as Exhibit 10(b) to
Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, and incorporated herein by reference.
(k)(1).
* Amended and Restated 1994 Stock Option Plan -- previously filed as Exhibit 10(r) to Annual Report on Form 10-K for
the year ended December 31, 1996, and incorporated herein by reference.
* First Amendment to Huntington Bancshares Incorporated 1994 Stock Option Plan -- previously filed as Exhibit 10(a) to
* First Amendment to Huntington Bancshares Incorporated Amended and Restated 1994 Stock Option Plan -- previously
filed as Exhibit 10(c) to Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, and incorporated
* Second Amendment to Huntington Bancshares Incorporated Amended and Restated 1994 Stock Option Plan -- previously
filed as Exhibit 10(d) to Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, and incorporated
* Third Amendment to Huntington Bancshares Incorporated Amended and Restated 1994 Stock Option Plan -- previously
filed as Exhibit 10(e) to Quarterly Report on Form 10-Q for the quarter ended March 31, 2002, and incorporated
(l)(1).
* Huntington Bancshares Incorporated 2001 Stock and Long-Term Incentive Plan -- previously filed as Exhibit 10(r) to
Quarterly Report 10-Q for the quarter ended March 31, 2001, and incorporated herein by reference.
* First Amendment to the Huntington Bancshares Incorporated 2001 Stock and Long-Term Incentive Plan -- previously
filed as Exhibit 10(h) to Quarterly Report 10-Q for the quarter ended March 31, 2002, and incorporated herein by
* Second Amendment to the Huntington Bancshares Incorporated 2001 Stock and Long-Term Incentive Plan -- previously
filed as Exhibit 10(i) to Quarterly Report 10-Q for the quarter ended March 31, 2002, and incorporated herein by
(m).
* Huntington Bancshares Incorporated 2004 Stock and Long-Term Incentive Plan -- previously filed as Exhibit 10(b) to
(n)(1).
* Huntington Bancshares Incorporated Employee Stock Incentive Plan (incorporating changes made by first amendment to
Plan) -- reference is made to Exhibit 4(a) of Registration Statement on Form S-8, Registration 333-75032, previously
filed with the Securities and Exchange Commission on December 13, 2001, and incorporated herein by reference.
* Second Amendment to Huntington Bancshares Incorporated Employee Stock Incentive Plan -- previously filed as Exhibit
10(s) to Annual Report on Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
(o).
* Performance criteria and potential awards for executive officers for fiscal year 2005 under the Management Incentive
Plan and for a long-term incentive award cycle beginning on January 1, 2005 and ending on December 31, 2007 under
the 2004 Stock and Long-Term Incentive Plan, as set forth in a Current Report on Form 8-K dated February 15, 2005,
and incorporated herein by reference.
(p).
* Compensation Schedule for Non-Employee Directors of Huntington Bancshares Incorporated, effective July 19, 2005 -
previously filed as Exhibit 99.1 to Current Report on Form 8-K dated July 19, 2005, and incorporated herein by reference.
(q).
* Employment Agreement, dated February 15, 2004, between Huntington Bancshares Incorporated and Thomas E. Hoaglin - previously filed as Exhibit 10(n) to Annual Report on Form 10-K for the year ended December 31, 2003, and incorporated herein by reference.
(r).
* Letter Agreement between Huntington Bancshares Incorporated and James W. Nelson, acknowledged and agreed to by Mr. Nelson on February 14, 2005 - previously filed as Exhibit 99.2 to Current Report on Form 8-K dated February 14, 2005, and incorporated herein by reference.
(s).
* Letter Agreement between Huntington Bancshares Incorporated and Mahesh Sankaran, acknowledged and agreed to by Mr. Sankaran on January 28, 2005 - previously filed as Exhibit 10(b) to Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, and incorporated herein by reference.
(t).
* Letter Agreement between Huntington Bancshares Incorporated and Raymond J. Biggs, acknowledged and agreed to by Mr. Biggs on May 1, 1995.
(u).
* Schedule identifying material details of Executive Agreements.
(v).
* Performance criteria and potential awards for executive officers for fiscal year 2006 under the Management Incentive Plan and for a long-term incentive award cycle beginning on January 1, 2006 and ending on December 31, 2008 under the 2004 Stock and Long-Term Incentive Plan, as set forth in a Current Report on Form 8-K dated February 21, 2006, and incorporated herein by reference.
Ratio of Earnings to Fixed Charges.
Portions of our 2005 Annual Report to shareholders.
Code of Business Conduct and Ethics dated January 14, 2003 and revised on February 14, 2006 and Financial Code of Ethics for Chief Executive Officer and Senior Financial Officers, adopted January 18, 2003 and revised on April 19, 2005, are available on our web site at http://www.investquest.com/iq/h/hban/main/cg/cg.htm.
Subsidiaries of the Registrant.
23.(a).
Consent of Deloitte & Touche LLP, Independent Registered Public Accounting Firm.
23.(b).
Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm.
Power of Attorney.
Rule 13a-14(a) Certification -- Chief Executive Officer.
Rule 13a-14(a) Certification -- Chief Financial Officer.
Section 1350 Certification -- Chief Executive Officer.
Section 1350 Certification -- Chief Financial Officer.
Opinion of Ernst & Young LLP, Independent Registered Public Accounting Firm.
Written Agreement between Huntington Bancshares Incorporated and the Federal Reserve Bank of Cleveland dated
February 28, 2005, as set forth in a Current Report on Form 8-K dated March 2, 2005, and incorporated herein by
* Denotes management contract or compensatory plan or arrangement.
Exhibit 10.(t).
Mr. Raymond J. Biggs
One North Main Street
Mt. Clemens, MI 48043
Dear Ray:
Brenda Warne and I discussed your elections with respect to handling of the New England Mutual Life Insurance Policy discussed below. Except for the changes required to reflect the insurance election, and the designation of beneficiary with respect to Paragraphs C and D below, the balance of this letter simply restates the commitments of my April 14, 1995, letter.
If you concur, these terms will supersede all prior understandings with respect to the subject matter covered:
The employment agreement dated January 1, 1990, between Huntington Bancshares Michigan, Inc. and Raymond J. Biggs is terminated in its entirety.
The Supplemental Retirement Income Plan/Agreement between First Macomb Corporation and Raymond J. Biggs dated January 1, 1985, as amended by Amendment to Supplement Retirement Income Plan/Agreement dated December 17, 1987, is terminated in its entirety. I have incorporated the retirement benefits below.
Commencing August 1, 2002, and for each month thereafter for a term of fifteen (15) years, Huntington shall cause to be paid to you the sum of $13,142.20 per month. In the event of your death subsequent to commencement of such benefits payments, but prior to the expiration of the fifteen year period, Huntington shall continue to make such payments during the remainder of the fifteen year term to your beneficiary. In the event of your death, prior to the commencement of such payments, Huntington shall thereafter pay to your beneficiary the sum of $13,142.20 per month for a term of fifteen years commencing on the first day of the month immediately following the date of death.
Effective February 7, 1990, you assigned and transferred all of your right, title and ownership interests in New England Mutual Life Insurance Policy No. 6539543 to:
First Macomb Bank
You have not acquired any interest in said policy.
Commencing May 1, 1995, and on May 1 of each succeeding year through and including May 1, 2009, when the final installment shall be due and payable, Huntington shall cause to be paid to you the sum of $15,159.00. In the event of your death prior to payment of the May 1, 2009 installment, Huntington shall continue to make such payments during the remainder of the term to your beneficiary.
For purposes of Paragraphs C and D of this letter, references to the term "beneficiary" shall mean "Raymond J. Biggs Family Trust, revocable intervivos trust, previously executed by Raymond J. Biggs as settlor on September 18, 1986 as the same may be amended prior to death". You reserve the right to change the designation of beneficiary by notifying Huntington Bancshares Incorporated in a signed and dated notice of such change.
Attached hereto as Exhibit A is a summary of additional Huntington benefits available to you at retirement.
Huntington will continue through June 30, 1997, to provide executive office space and a part-time secretary for your use. During this period you agree not to engage in the banking business as a director, officer, employee or agent of any other financial institution located in the Detroit Primary Metropolitan Statistical Area without the prior written consent of Huntington Bancshares Incorporated.
I believe the above accurately reflects our understandings, and if you concur, we will consider the referenced agreements terminated by mutual agreement; and the claim reflected in your letter of March 28, 1995, to be withdrawn. Please indicate your agreement to these terms by executing and returning to me the enclosed copy of this letter.
/s/ Zuheir Sofia
Zuheir Sofia
The terms stated above accurately reflect our agreement this 1st day of May, 1995.
/s/ Ryamond J. Biggs
cc: Brenda Warne, Vice President
RAYMOND BIGGS
SUMMARY OF HUNTINGTON BENEFITS AT TERMINATION OF EMPLOYMENT
I. Retiree Health Care
You elected to receive retiree health care for both yourself and your spouse. Your monthly subsidy from the Huntington for this benefit is $260.00.
II. Huntington Stock Purchase and Tax Savings Plan ("Stock Plan")
As of February 28, 1995, you have 6357.3315 shares of Huntington Bancshares Incorporated common stock ("HBI Stock") and $72,960.01 in the Alternative Investment Fund in your account in the Stock Plan. You have not yet requested distribution of your account in the Stock Plan.
III. Huntington Supplemental Stock Purchase and Tax Savings Plan ("Supplemental Plan")
As of February 28, 1995, you have 1,439.518 shares of HBI Stock in your account in the Supplemental Plan. Huntington Trust Company is currently processing your distribution from the Supplemental Plan.
IV. Huntington Bancshares Retirement Plan ("Pension Plan")
Your early retirement benefit (as of January 1, 1995) under the Pension Plan was $857.54, payable monthly in the form of a life annuity. You had a variety of optional forms of benefit available. All optional forms were the actuarial equivalent of the life annuity amount
You have not yet elected to commence receipt of your accrued benefit under the Pension Plan. Your accrued benefit, payable at your normal retirement date of August 1, 2002, is $1,208.83, payable monthly in the form of a life annuity. At the time you notify the Huntington, in writing, that you are electing to commence receipt of your benefits under the Pension Plan, your accrued benefit and available optional forms of distribution will be determined and communicated to you.
V. Life Insurance
You have life insurance coverage in the amount of $27,300.
Exhibit 10.(u).
Schedule Identifying Material Details of
Executive Agreements Substantially Similar to Exhibit 99.1 to Huntington's
Current Report on Form 8-K dated November 21, 2005
Ronald C. Baldwin
Thomas E. Hoaglin
Daniel B. Benhase
Richard A. Cheap
Mary W. Navarro
Nicholas G. Stanutz
James W. Nelson
Mahesh Sankaran
Exhibit 12
Ratio of Earnings to Fixed Charges
Year Ended December 31,
(in thousands of dollars) 2005 2004 2003 2002 2001
Earnings:
$ 543,574 $ 552,666 $ 523,987 $ 522,705 $ 95,477
Add: Fixed charges, excluding interest on deposits
243,239 191,648 179,903 169,788 299,872
Earnings available for fixed charges, excluding interest on deposits
Add: Interest on deposits
Earnings available for fixed charges, including interest on deposits
$ 1,233,732 $ 1,001,413 $ 992,161 $ 1,078,226 $ 1,049,405
Fixed Charges:
Interest expense, excluding interest on deposits
$ 232,435 $ 178,842 $ 168,499 $ 157,888 $ 285,445
Interest factor in net rental expense
10,804 12,806 11,404 11,900 14,427
Total fixed charges, excluding interest on deposits
Total fixed charges, including interest on deposits
Excluding interest on deposits
3.23x 3.88x 3.91x 4.08x 1.32x
Including interest on deposits
S ELECTED F INANCIAL D ATA HUNTINGTON BANCSHARES INCORPORATED
Table 1 — Selected Financial Data
(in thousands of dollars, except per share amounts) 2005 2004 2003 2002 2001
$ 1,641,765 $ 1,347,315 $ 1,305,756 $ 1,293,195 $ 1,654,789
Net interest income
Provision for credit losses
81,299 55,062 163,993 194,426 257,326
Net interest income after provision for credit losses
Service charges on deposit accounts
Operating lease income
Gain on sales of automobile loans
1,211 14,206 40,039 — —
Gain on sale of branch offices
— — 13,112 — —
Gain on sale of Florida operations
— — — 182,470 —
Merchant services gain
— — — 24,550 —
Securities gains (losses)
(8,055 ) 15,763 5,258 4,902 723
Other non-interest income
Total non-interest income
632,282 818,598 1,069,153 1,341,704 1,199,942
Personnel costs
Operating lease expense
Restructuring reserve (releases) charges
— (1,151 ) (6,666 ) 48,973 79,957
Loss on early extinguishment of debt
Other non-interest expense
Total non-interest expense
969,820 1,122,244 1,230,159 1,374,147 1,562,427
Income before income taxes
543,574 552,666 523,987 522,705 95,477
Provision (benefit) for income taxes
131,483 153,741 138,294 198,974 (39,319 ) (5)
Income before cumulative effect of change in accounting principle
Cumulative effect of change in accounting principle, net of tax (1)
— — (13,330 ) — —
Income before cumulative effect of change in accounting
principle per common share — basic
$ 1.79 $ 1.74 $ 1.68 $ 1.34 $ 0.54
Net Income per common share — basic
principle per common share — diluted
Net Income per common share — diluted
Cash dividends declared
0.845 0.750 0.670 0.640 0.720
Balance sheet highlights
Total assets (period end)
$ 32,764,805 $ 32,565,497 $ 30,519,326 $ 27,539,753 $ 28,458,769
Total long-term debt (period end) (2)
4,597,437 6,326,885 6,807,979 4,246,801 2,739,332
Total shareholders' equity (period end)
Average long-term debt (2)
Average shareholders' equity
Average total assets
32,639,011 31,432,746 28,971,701 26,063,281 28,126,386
Key ratios and statistics
Margin analysis — as a % of average earnings assets
Interest income (3)
Net interest margin (3)
Return on average total assets
Return on average total shareholders' equity
Efficiency ratio (4)
Dividend payout ratio
47.7 43.9 41.6 48.1 133.3
Average shareholders' equity to average assets
24.2 27.8 26.4 38.1 (41.2 ) (5)
Tangible equity to asset (period end) (6)
Tier 1 leverage ratio
Tier 1 risk-based capital ratio (period end)
Total risk-based capital ratio (period end)
Full-time equivalent employees
Domestic banking offices
(1) Due to the adoption of FASB Interpretation No. 46 " Consolidation of Variable Interest Entities ."
(2) Includes Federal Home Loan Bank advances, other long-term debt, and subordinated notes.
(3) On a fully taxable equivalent (FTE) basis assuming a 35% tax rate.
(4) Non-interest expense less amortization of intangibles divided by the sum of FTE net interest income and non-interest income excluding securities gains.
(5) Reflects a $32.5 million reduction related to the issuance of $400 million REIT subsidiary preferred stock, of which $50 million was sold to the public.
(6) Total equity minus intangible assets divided by total assets minus intangible assets.
M ANAGEMENT'S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION HUNTINGTON BANCSHARES INCORPORATED
AND R ESULTS OF O PERATIONS
Huntington Bancshares Incorporated (we or our) is a multi-state diversified financial holding company organized under Maryland law in 1966 and headquartered in Columbus, Ohio. Through our subsidiaries, we provide full-service commercial and consumer banking services, mortgage banking services, automobile financing, equipment leasing, investment management, trust services, brokerage services, private mortgage insurance; reinsure credit life and disability insurance; and sell other insurance and financial products and services. Our banking offices are located in Ohio, Michigan, West Virginia, Indiana, and Kentucky. Certain activities are also conducted in Arizona, Florida, Georgia, Maryland, Nevada, New Jersey, North Carolina, Pennsylvania, South Carolina, and Tennessee. We have a foreign office in the Cayman Islands and another in Hong Kong. The Huntington National Bank (the Bank), organized in 1866, is our only bank subsidiary.
The following discussion and analysis provides you with information we believe necessary for understanding our financial condition, changes in financial condition, results of operations, and cash flows and should be read in conjunction with the financial statements, notes, and other information contained in this report.
You should note the following discussion is divided into key segments:
– INTRODUCTION — Provides overview comments on important matters including risk factors, the now settled Securities and Exchange Commission (SEC) investigation, any bank regulatory agreements, and critical accounting policies and the use of significant estimates. These are essential for understanding our performance and prospects.
– DISCUSSION OF RESULTS OF OPERATIONS — Reviews financial performance from a consolidated company perspective. It also includes a Significant Factors Influencing Financial Performance Comparisons section that summarizes key issues helpful for understanding performance trends. Key consolidated balance sheet and income statement trends are also discussed in this section.
– RISK MANAGEMENT AND CAPITAL — Discusses credit, market, liquidity, and operational risks, including how these are managed, as well as performance trends. It also includes a discussion of liquidity policies, how we fund ourselves, and related performance. In addition, there is a discussion of guarantees and/or commitments made for items such as standby letters of credit and commitments to sell loans, and a discussion that reviews the adequacy of capital including regulatory capital requirements.
– LINES OF BUSINESS DISCUSSION — Provides an overview of financial performance for each of our major lines of business and provides additional discussion of trends underlying consolidated financial performance.
– RESULTS FOR THE FOURTH QUARTER — Provides a discussion of results for the 2005 fourth quarter compared with the year-earlier quarter.
A reading of each section is important for you to understand fully the nature of our financial performance and prospects.
This report, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements. These include descriptions of products or services, plans or objectives for future operations, including any pending acquisitions, and forecasts of revenues, earnings, cash flows, or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.
By their nature, forward-looking statements are subject to numerous assumptions, risks, and uncertainties. A number of factors could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to, those set forth under Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2005, and other factors described in this report and from time to time in our other filings with the SEC.
You should understand forward-looking statements to be strategic objectives and not absolute forecasts of future performance. Forward-looking statements speak only as of the date they are made. We assume no obligation to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements were made or to reflect the occurrence of unanticipated events.
We, like other financial companies, are subject to a number of risks, many of which are outside of our direct control, though efforts are made to manage those risks while optimizing returns. Among the risks assumed are: (1) credit risk , which is the risk that loan and lease customers or other counterparties will be unable to perform their contractual obligations, (2) market risk ,
M ANAGEMENT'S D ISCUSSION AND A NALYSIS HUNTINGTON BANCSHARES INCORPORATED
which is the risk that changes in market rates and prices will adversely affect our financial condition or results of operation, (3) liquidity risk , which is the risk that the parent company and/or the Bank will have insufficient cash or access to cash to meet operating needs, and (4) operational risk , which is the risk of loss resulting from inadequate or failed internal processes, people and systems, or external events. More information on risks is set forth in Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2005.
Securities and Exchange Commission Formal Investigation
On June 26, 2003, we announced that the SEC staff was conducting a formal investigation into certain financial accounting matters, relating to fiscal years 2002 and earlier, and certain related disclosure matters.
On June 2, 2005, we announced that the SEC approved the settlement of their formal investigation. As a part of the settlement, the SEC instituted a cease and desist administrative proceeding and entered a cease and desist order, as well as filed a civil action in federal district court pursuant to which, without admitting or denying the allegations in the complaint, we, our chief executive officer, former chief financial officer, and former controller, consented to pay civil money penalties. We consented to pay a penalty of $7.5 million, which may be distributed pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002. This civil money penalty had no impact on our 2005 financial results, as reserves for this amount were established and expensed in 2004.
Formal Regulatory Supervisory Agreements and Pending Acquisition
On March 1, 2005, we announced entering into a formal written agreement with the Federal Reserve Bank of Cleveland (FRBC), as well as the Bank entering into a formal written agreement with the Office of the Comptroller of the Currency (OCC), providing for a comprehensive action plan designed to enhance corporate governance, internal audit, risk management, accounting policies and procedures, and financial and regulatory reporting. The agreements called for independent third-party reviews, as well as the submission of written plans and progress reports by Management, and would remain in effect until terminated by the banking regulators.
On October 6, 2005, we announced that the OCC had terminated its formal written agreement with the Bank dated February 28, 2005, and that the FRBC written agreement remained in effect. We were verbally advised that we were in full compliance with the financial holding company and financial subsidiary requirements under the Gramm-Leach-Bliley Act (GLB Act). This notification reflected that we and the Bank met both the "well-capitalized" and "well-managed" criteria under the GLB Act. We believe that the changes we have already made, and are in the process of making, will address the FRBC issues fully and comprehensively.
On January 27, 2004, we announced the signing of a definitive agreement to acquire Unizan Financial Corp. (Unizan), a financial holding company based in Canton, Ohio. On November 12, 2004, the companies jointly announced entering into an amendment to our January 26, 2004 merger agreement extending the term of the agreement for one year from January 27, 2005 to January 27, 2006. On the same date, we also announced that we withdrew our application with the FRBC to acquire Unizan. On October 24, 2005, we announced that, after consultation with the FRBC, we had re-filed our application to acquire Unizan. On January 26, 2006, we announced that the Federal Reserve Board had approved our merger application. The merger is scheduled to close March 1, 2006.
Critical Accounting Policies and Use of Significant Estimates
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The preparation of financial statements in conformity with GAAP requires us to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in our financial statements. Note 1 of the Notes to Consolidated Financial Statements included in this report lists significant accounting policies we use in the development and presentation of our financial statements. This discussion and analysis, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors necessary for an understanding and evaluation of our company, financial position, results of operations, and cash flows.
An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements if a different amount within a range of estimates were used or if estimates changed from period to period. You should understand that estimates are made under facts and circumstances at a point in time, and changes in those facts and circumstances could produce actual results that differ from when those estimates were made. The most significant accounting estimates and their related application are discussed below. This analysis is included to emphasize that estimates are used in
connection with the critical and other accounting policies and to illustrate the potential effect on the financial statements if the actual amount were different from the estimated amount.
– TOTAL ALLOWANCES FOR CREDIT LOSSES — At December 31, 2005, the total allowances for credit losses (ACL) was $305.3 million and represented the sum of the allowance for loan and lease losses (ALLL) and the allowance for unfunded loan commitments and letters of credit (AULC). The amount of the ACL was determined by our judgments regarding the quality of the loan portfolio, including loan commitments. All known relevant internal and external factors that affected loan collectibility were considered. The ACL represents the estimate of the level of reserves appropriate to absorb inherent credit losses. We believe the process for determining the ACL considers all of the significant potential factors that could result in credit losses. However, the process includes judgmental and quantitative elements that may be subject to significant change. To the extent actual outcomes differ from our estimates, additional provision for credit losses could be required, which could adversely affect earnings or financial performance in future periods. At December 31, 2005, the ACL as a percent of total loans and leases was 1.25%. Based on the December 31, 2005 balance sheet, a 10 basis point increase in this ratio to 1.35% would require $25.1 million in additional reserves funded by additional provision for credit losses, which would have negatively impacted 2005 net income by approximately $16.3 million, or $0.07 per share. A discussion about the process used to estimate the ACL is presented in the Credit Risk section of Management's Discussion and Analysis in this report.
– FAIR VALUE OF FINANCIAL INSTRUMENTS — A significant portion of our assets is carried at fair value, including securities, derivatives, and trading assets. Additionally, a smaller portion is carried at the lower of fair value or cost, including held-for-sale loans and mortgage servicing rights (MSRs). At December 31, 2005, approximately $4.9 billion of our assets were recorded at either fair value or at the lower of fair value or cost.
The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The majority of assets reported at fair value are based on quoted market prices or on internally developed models that utilize independently sourced market parameters, including interest rate yield curves, option volatilities, and currency rates.
We estimate the fair value of a financial instrument using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When observable market prices do not exist, we estimate fair value. Our valuation methods consider factors such as liquidity and concentration concerns and, for the derivatives portfolio, counterparty credit risk. Other factors such as model assumptions, market dislocations, and unexpected correlations can affect estimates of fair value. Imprecision in estimating these factors can impact the amount of revenue or loss recorded for a particular position.
Trading securities and securities available-for-sale
Substantially all of our securities are valued based on quoted market prices. However, certain securities are less actively traded. These securities do not always have quoted market prices. The determination of their fair value, therefore, requires judgment, as this determination may require benchmarking to similar instruments or analyzing default and recovery rates. Examples include certain collateralized mortgage and debt obligations and high-yield debt securities.
Our securities available-for-sale are valued using quoted market prices. Our derivative positions are valued using internally developed models based on observable market parameters — that is, parameters that are actively quoted and can be validated to external sources, including industry-pricing services.
Loans held-for-sale
The fair value of loans in the held-for-sale portfolio is generally based on observable market prices of similar instruments. If market prices are not available, fair value is based on the estimated cash flows, adjusted for credit risk. The credit risk adjustment is discounted using a rate that is appropriate for each maturity and incorporates the effects of interest rate changes.
MSRs and other servicing rights
MSRs and certain other servicing rights do not trade in an active, open market with readily observable prices. While sales of MSRs occur, the precise terms and conditions are typically not readily available. Therefore, we estimate the fair value of MSRs and certain other servicing rights using a discounted future cash flow model. For MSRs and certain other servicing rights, the model considers portfolio characteristics, contractually specified servicing fees and assumptions related to prepayments, delinquency rates, late charges, other ancillary revenues, costs to service, and other economic factors. Changes in the assumptions used may have a significant impact on the valuation of these financial instruments. We believe that the fair values and related assumptions used in the models are comparable to those used by other market participants. Note 5 of
the Notes to Consolidated Financial Statements contains an analysis of the impact to the fair value of MSRs resulting from changes in the estimates used by Management.
– INCOME TAXES — The calculation of our periodic provision for income taxes is complex and requires the use of estimates and judgments. We have two accruals for income taxes: our accrued income taxes represent the net estimated amount currently due or to be received from taxing jurisdictions, including any reserve for potential examination issues, and is reported as a component of "accrued expenses and other liabilities" in our consolidated balance sheet; and our deferred income tax liability represents the estimated impact of temporary differences between how we recognize our assets and liabilities under GAAP, and how such assets and liabilities are recognized under the federal tax code.
From time to time, we engage in business transactions that may have an effect on our tax liabilities. Where appropriate, we have obtained opinions of outside experts and have assessed the relative merits and risks of the appropriate tax treatment of business transactions taking into account statutory, judicial, and regulatory guidance in the context of our tax position. However, changes to our estimates of accrued taxes can occur due to changes in tax rates, implementation of new business strategies, resolution of issues with taxing authorities regarding previously taken tax positions and newly enacted statutory, judicial, and regulatory guidance. Such changes could affect the amount of our accrued taxes and could be material to our results of operations.
Table 2 — Selected Annual Income Statements
Change from 2004 Change from 2003
(in thousands, except per share amounts) 2005 Amount % 2004 Amount % 2003 2002 2001
$ 1,641,765 $ 294,450 21.9 % $ 1,347,315 $ 41,559 3.2 % $ 1,305,756 $ 1,293,195 $ 1,654,789
679,354 243,413 55.8 435,941 (20,829 ) (4.6 ) 456,770 543,621 939,501
962,411 51,037 5.6 911,374 62,388 7.3 848,986 749,574 715,288
81,299 26,237 47.7 55,062 (108,931 ) (66.4 ) 163,993 194,426 257,326
881,112 24,800 2.9 856,312 171,319 25.0 684,993 555,148 457,962
167,834 (3,281 ) (1.9 ) 171,115 3,275 2.0 167,840 153,564 165,012
138,433 (148,658 ) (51.8 ) 287,091 (202,607 ) (41.4 ) 489,698 657,074 691,733
77,405 9,995 14.8 67,410 5,761 9.3 61,649 62,051 60,298
Brokerage and insurance income
53,619 (1,180 ) (2.2 ) 54,799 (3,045 ) (5.3 ) 57,844 62,109 75,013
Other service charges and fees
44,348 2,774 6.7 41,574 128 0.3 41,446 42,888 48,217
Mortgage banking
41,710 9,414 29.1 32,296 (25,884 ) (44.5 ) 58,180 32,033 54,518
Bank owned life insurance income
40,736 (1,561 ) (3.7 ) 42,297 (731 ) (1.7 ) 43,028 43,123 41,123
1,211 (12,995 ) (91.5 ) 14,206 (25,833 ) (64.5 ) 40,039
— — — — (13,112 ) N.M. 13,112 — —
— — — — — — — 182,470 —
— — — — — — 24,550 —
(8,055 ) (23,818 ) N.M. 15,763 10,505 N.M. 5,258 4,902 723
75,041 (17,006 ) (18.5 ) 92,047 988 1.1 91,059 76,940 63,305
632,282 (186,316 ) (22.8 ) 818,598 (250,555 ) (23.4 ) 1,069,153 1,341,704 1,199,942
481,658 (4,148 ) (0.9 ) 485,806 38,543 8.6 447,263 418,037 454,210
Outside data processing and other services
74,638 2,523 3.5 72,115 5,997 9.1 66,118 67,368 69,692
Net occupancy
71,092 (4,849 ) (6.4 ) 75,941 13,460 21.5 62,481 59,539 76,449
63,124 (218 ) (0.3 ) 63,342 (2,579 ) (3.9 ) 65,921 68,323 80,560
34,569 (2,307 ) (6.3 ) 36,876 (5,572 ) (13.1 ) 42,448 33,085 32,862
28,077 1,588 6.0 26,489 (1,001 ) (3.6 ) 27,490 27,911 31,057
Printing and supplies
12,573 110 0.9 12,463 (546 ) (4.2 ) 13,009 15,198 18,367
Amortization of intangibles
829 12 1.5 817 1 0.1 816 2,019 41,225
— 1,151 N.M. (1,151 ) 5,515 (82.7 ) (6,666 ) 48,973 79,957
76,236 (17,045 ) (18.3 ) 93,281 12,501 15.5 80,780 92,063 91,438
969,820 (152,424 ) (13.6 ) 1,122,244 (107,915 ) (8.8 ) 1,230,159 1,374,147 1,562,427
543,574 (9,092 ) (1.6 ) 552,666 28,679 5.5 523,987 522,705 95,477
Provision (benefit) for income taxes (3)
131,483 (22,258 ) (14.5 ) 153,741 15,447 11.2 138,294 198,974 (39,319 )
— — — — 13,330 N.M. (13,330 ) — —
$ 412,091 $ 13,166 3.3 % $ 398,925 $ 26,562 7.1 % $ 372,363 $ 323,731 $ 134,796
Average common shares — basic
230,142 229 0.1 % 229,913 512 0.2 % 229,401 242,279 251,078
Average common shares — diluted
233,475 (381 ) (0.2 ) 233,856 2,274 1.0 231,582 244,012 251,716
Per common share:
Income before cumulative effect of change in accounting principle — basic
$ 1.79 $ 0.05 2.9 % $ 1.74 $ 0.06 3.6 % $ 1.68 $ 1.34 $ 0.54
Net income — basic
1.79 0.05 2.9 1.74 0.12 7.4 1.62 1.34 0.54
Income before cumulative effect of change in accounting principle — diluted
Net income — diluted
0.845 0.10 12.7 0.750 0.08 11.9 0.670 0.640 0.720
Revenue — fully taxable equivalent (FTE)
Net interest income $ 962,411 $ 51,037 5.6 % $ 911,374 $ 62,388 7.3 % $ 848,986 $ 749,574 $ 715,288
FTE adjustment 13,393 1,740 14.9 11,653 1,969 20.3 9,684 5,205 6,352
Net interest income (2)
Non-interest income
Total revenue (2)
$ 1,608,086 $ (133,539 ) (7.7 )% $ 1,741,625 $ (186,198 ) (9.7 )% $ 1,927,823 $ 2,096,483 $ 1,921,582
N.M., not a meaningful value.
(1) Due to adoption of FASB Interpretation No. 46 for variable interest entities.
(2) Calculated assuming a 35% tax rate.
(3) 2001 reflects a $32.5 million reduction related to the issuance of $400 million REIT subsidiary preferred stock, of which $50 million was sold to the public.
DISCUSSION OF RESULTS OF OPERATIONS
This section provides a review of financial performance from a consolidated perspective. It also includes a Significant Factors Influencing Financial Performance Comparisons section that summarizes key issues important for a complete understanding of performance trends. Key consolidated balance sheet and income statement trends are discussed in this section. All earnings per share data are reported on a diluted basis. For additional insight on financial performance, this section should be read in conjunction with the Lines of Business Discussion.
2005 versus 2004
Earnings for 2005 were $412.1 million, or $1.77 per common share, up 3% and 4%, respectively, from $398.9 million, or $1.71 per common share, in 2004. The $13.2 million increase in net income primarily reflected:
– $152.4 million, or 14%, decline in non-interest expense, primarily reflecting a $128.1 million decline in operating lease expenses, a $9.9 million decline in SEC-related expenses, a $4.8 million decline in net occupancy expense, a $4.1 million decline in personnel costs, and a $2.9 million decline in Unizan system conversion expenses.
– $51.0 million, or 6%, increase in net interest income, reflecting a 6% increase in average earning assets, as the net interest margin of 3.33% was unchanged from the prior year. The increase in average earning assets reflected 10% growth in average total loans and leases, including 11% growth in average total consumer loans and 8% growth in average total commercial loans, partially offset by a 14% decline in average investment securities.
– $22.3 million decline in income tax expense as the effective tax rate for 2005 was 24.2%, down from 27.8% in 2004. The lower 2005 income tax expense reflected a combination of factors including the benefit of a federal tax loss carry back, partially offset by the net impact of repatriating foreign earnings.
Partially offset by:
– $186.3 million, or 23%, decline in non-interest income. Contributing to the decrease were a $148.7 million decline in operating lease income, a $23.8 million decline in securities gains as the current year had $8.1 million of securities losses and the prior year had $15.8 million of securities gains, a $13.0 million decline in gains on sales of automobile loans, a $17.0 million decline in other income reflecting primarily MSR-hedge related trading losses, and a $3.3 million decline in service charges on deposit accounts. These declines were partially offset by a $10.0 million increase in trust services income, a $9.4 million increase in mortgage banking income, and a $2.8 million increase in other service charges and fees.
– $26.2 million, or 48%, increase in the provision for credit losses, reflecting higher levels of non-performing assets and problem credits, as well as growth in the loan portfolio.
The ROA and ROE for 2005 were 1.26% and 16.0%, respectively, down slightly from 1.27% and 16.8%, respectively, in 2004.
– $108.9 million, or 66%, decline in the provision for credit losses, reflecting lower levels of non-performing assets and problem credits, only partially offset by the impact of loan growth.
– $107.9 million, or 9%, decline in non-interest expense, primarily reflecting a $156.8 million decline in operating lease expenses, a $15.3 million loss on early extinguishment of debt expense in 2003, a $5.6 million decline in professional services, and declines in equipment, marketing, telecommunications, and printing and supplies. These declines were partially offset by a $38.5 million increase in personnel costs, a $13.5 million increase in net occupancy expense, a $6.7 million increase in SEC/regulatory-related expenses, and $3.6 million of Unizan system conversion expenses, as the prior year did not have these expenses.
– $62.4 million, or 7%, increase in net interest income, reflecting a 13% increase in average earning assets, partially offset by the negative impact of a 16 basis point, or an effective 5%, decline in the net interest margin to 3.33% from 3.49%. The increase in average earning assets reflected 11% growth in average total loans and leases, including 16% growth in average total consumer loans, 4% growth in average total commercial loans, and a 25% increase in average investment securities.
– $250.6 million, or 23%, decline in non-interest income. Contributing to the decrease were a $202.6 million decline in operating lease income, a $25.9 million decline in mortgage banking income, a $25.8 million decline in gains on sales of automobile loans, and the fact that 2003 benefited from a $13.1 million gain on sale of branch offices. Partially offsetting these declines were $10.5 million of higher securities gains, a $5.8 million increase in trust income, and a $3.3 million increase in service charges on deposits.
– $15.4 million increase in income tax expense as the effective tax rate for 2004 was 27.8%, up from 26.4% in 2003.
The ROA and ROE for 2004 were 1.27% and 16.8%, respectively, down from 1.29% and 17.0%, respectively, in 2003.
Significant Factors Influencing Financial Performance Comparisons
Earnings comparisons from 2003 through 2005 were impacted by a number of factors, some related to changes in the economic and competitive environment, while others reflected specific management strategies or changes in accounting practices. Those key factors are summarized below.
1. AUTOMOBILE LEASES ORIGINATED THROUGH APRIL 2002 ARE ACCOUNTED FOR AS OPERATING LEASES. — Automobile leases originated before May 2002 are accounted for using the operating lease method of accounting because they do not qualify as direct financing leases. Operating leases are carried in other assets with the related rental income, other revenue, and credit recoveries reflected as operating lease income, a component of non-interest income. Under this accounting method, depreciation expenses, as well as other costs and charge-offs, are reflected as operating lease expense, a component of non-interest expense. With no new operating leases originated since April 2002, the operating lease assets have declined rapidly. It is anticipated that the level of operating lease assets and related operating lease income and expense will decline to a point of diminished materiality sometime in 2006. However, until that point is reached, and since operating lease income and expense represented a significant percentage of total non-interest income and expense, respectively, throughout these reporting periods, their downward trend influenced total revenue, total non-interest income, and total non-interest expense trends.
In contrast, automobile leases originated since April 2002 are accounted for as direct financing leases, an interest earning asset included in total loans and leases with the related income reflected as interest income and included in the calculation of the net interest margin. Credit charge-offs and recoveries are reflected in the ALLL, with related changes in the ALLL reflected in the provision for credit losses. The relative newness and rapid growth of the direct financing lease portfolio resulted in higher reported automobile lease growth rates than in a more mature portfolio, especially in 2002 through 2004. To better understand overall trends in automobile lease exposure, it is helpful to compare trends in the combined total of direct financing leases plus operating leases.
2. MORTGAGE SERVICING RIGHTS (MSRS) AND RELATED HEDGING. — Interest rate levels throughout this period have remained low by historical standards, though they have generally been rising in 2004 and 2005. They have also been volatile, with increases in one quarter followed by declines in another and vice versa. This has impacted the valuation of MSRs, which can be volatile when rates change.
– Since the second quarter of 2002, we have generally retained the servicing on mortgage loans we originate and sell. MSR values are very sensitive to movements in interest rates as expected future net servicing income depends on the projected outstanding principal balances of the underlying loans, which can be greatly reduced by prepayments. Prepayments usually increase when mortgage interest rates decline and decrease when mortgage interest rates rise. Thus, as interest rates decline, less future income is expected and the value of MSRs declines. We recognize impairment when the valuation is less than the recorded book value. We recognize temporary impairment due to changes in interest rates through a valuation reserve and record a direct write-down of the book value of MSRs for other-than-temporary declines in valuation. Changes and fluctuations in interest rate levels between quarters resulted in some quarters reporting an MSR temporary impairment, with others reporting a recovery of previously recognized MSR temporary impairment. Such swings in MSR valuations have significantly impacted quarterly mortgage banking income trends throughout this period.
– Prior to 2004, we used investment securities as the primary method of offsetting MSR temporary valuation changes. Beginning in 2004, we have used trading account assets. The valuations of trading and investment securities generally react to interest rate changes in an opposite direction compared with changes in MSR valuations. As a
result, changes in interest rate levels that impacted MSR valuations also resulted in securities or trading gains or losses. As such, in quarters where an MSR impairment was recognized, investment securities and/or trading account assets were sold, typically resulting in a gain on sale or trading income, and vice versa. Investment securities gains or losses are reflected in the income statement in a single non-interest income line item, whereas trading gains or losses are a component of other non-interest income on the income statement ( see Tables 3 and 7) .
3. THE SALE OF AUTOMOBILE LOANS. — Beginning in 2003, a key strategy has been to lower our credit exposure to automobile loans and leases to 20% or less of total credit exposure, primarily by selling automobile loans. This objective was achieved during the 2005 first quarter. These sales of loans impacted results in a number of ways including: lower growth rates in automobile, total consumer, and total loans; and lower net interest income than otherwise would be the case if the loans were not sold. In addition, during 2004 such sales resulted in the generation of significant gains as large pools of automobile loans were sold in order to achieve the objective, with such gains reflected in non-interest income. In the 2005 second quarter, we entered into an arrangement to sell 50%-75% of automobile loan production to a third party on an on-going basis and retain the loan servicing as part of a strategy to maintain automobile loans and leases total credit exposure. While this flow-sale program resulted in modest gains in 2005, we view such gains as recurring given their on-going nature (see Table 3) .
4. SIGNIFICANT C&I AND CRE CHARGE-OFFS AND RECOVERIES. — A single commercial credit recovery in the 2004 second quarter on a loan previously charged off in the 2002 fourth quarter, favorably impacted the 2004 second quarter and full year provision expense (see Table 17) , as well as middle-market commercial and industrial, total commercial, and total net charge-offs for the 2004 second quarter and full year period (see Table 19). In addition, in the 2005 first quarter, a single large commercial credit was charged-off. This impacted 2005 first quarter and full year period total net charge-offs and provision expense (see Tables 3, 17, and 19).
5. EXPENSES AND ACCRUALS ASSOCIATED WITH THE SEC FORMAL INVESTIGATION AND BANKING REGULATORY FORMAL WRITTEN AGREEMENTS. — On June 26, 2003, we announced that the SEC staff was conducting a formal investigation into certain financial accounting matters, relating to fiscal years 2002 and earlier, and certain related disclosure matters. In addition, on March 1, 2005, we announced entering into a formal written agreement with the FRBC, as well as the Bank entering into a formal written agreement with the OCC, providing for a comprehensive action plan designed to enhance corporate governance, internal audit, risk management, accounting policies and procedures, and financial and regulatory reporting. On June 2, 2005, we announced that the SEC approved the settlement of their formal investigation. As a part of the settlement, we consented to pay a penalty of $7.5 million. This civil money penalty had no impact on our 2005 financial results, as reserves for this amount were established and expensed in 2004. These matters resulted in certain expenses and accruals as detailed below:
(in millions of dollars) 2005 2004 2003
$ 2.0 $ 0.7 $ —
— 5.5 4.7
Full year
$ 3.7 $ 13.6 $ 6.9
6. EFFECTIVE TAX RATE. — In each quarter of 2005, the effective tax rate included the after-tax positive impact on net income due to a federal tax loss carry back, tax exempt income, bank owned life insurance, asset securitization activities, and general business credits from investment in low income housing and historic property partnerships. In addition, the 2005 third quarter and full-year effective tax rates reflected a $5.0 million after-tax negative net impact, primarily in increased income tax expense, resulting from the repatriation of foreign earnings. In 2006, the effective tax rate is anticipated to increase to a more typical rate just below 30%.
7. OTHER SIGNIFICANT ITEMS INFLUENCING EARNINGS PERFORMANCE COMPARISONS. — From the first quarter of 2003 through the fourth quarter of 2005, and in addition to other items discussed separately in this section, a number of significant items impacted financial results. These included:
– $8.1 million pre-tax of investment securities losses related to a decision made during the 2005 fourth quarter to restructure a portion of the investment portfolio to replace lower rate securities with higher rate securities. This item lowered non-interest income.
– $5.1 million pre-tax of severance and consolidation expenses associated with the consolidation of certain operations functions, including the closing of an item-processing center in Michigan. This item increased non-interest expense.
– $2.1 million pre-tax write-off of an equity investment in the 2005 second quarter. This item lowered non-interest income.
– $7.8 million pre-tax of property lease impairments. This item increased non-interest expense.
– $3.6 million pre-tax of Unizan system conversion expense. This item increased non-interest expense.
– $3.7 million pre-tax one-time funding cost adjustment for a securitization structure consolidated in a prior period, which lowered interest expense and increased net interest income, as well as the net interest margin.
– $1.2 million pre-tax restructuring reserve release related to reserves established in conjunction with the 2002 sale of the Florida banking and insurance operations that were no longer needed. This item lowered non-interest expense.
– $15.3 million pre-tax non-interest expense due to the early termination of long-term debt. This item increased non-interest expense.
– $13.1 million pre-tax gain from the sale of our Martinsburg, West Virginia area branches. This item increased non-interest income.
– $13.3 million after-tax cumulative effect of adopting FASB Interpretation No. 46, Consolidation of Variable Interest Entities . This item lowered net income.
– $6.7 million pre-tax restructuring reserve release related to reserves that were no longer needed, which were established in conjunction with the sale of the Florida banking and insurance operations. This item lowered non-interest expense.
Table 3 — Significant Items Influencing Earnings Performance Comparison (1)
(in thousands of dollars) After-tax EPS After-tax EPS After-tax EPS
Net income — GAAP
$ 412,091 $ 398,925 $ 372,363
Earnings per share, after tax
Change from prior year — $
Change from prior year — %
3.5 % 6.2 % 21.1 %
Significant items — favorable (unfavorable) impact:
Earnings (3 ) EPS Earnings (3 ) EPS Earnings (3 ) EPS
MSR valuation (impairment) recovery, net of hedge-related trading activity
$ (7,318 ) $ (0.02 ) $ (7,174 ) $ (0.02 ) $ 14,957 $ 0.04
Gain on sale of automobile loans
— — 14,206 0.04 40,039 0.11
Single commercial credit net charge-off net of allocated reserves
(6,449 ) (0.02 ) — — — —
Single commercial credit recovery
— — 11,095 0.03 — —
SEC/regulatory related expenses
(3,715 ) (0.01 ) (13,597 ) (0.05 ) (6,859 ) (0.02 )
Net impact of federal tax loss carry back (4)
26,936 0.12 — — — —
(8,055 ) (0.02 ) 15,763 0.04 5,258 0.01
Net impact of repatriating foreign earnings (4)
Severance and consolidation expenses
Write-off of equity investment
Property lease impairment
— — (7,846 ) (0.02 ) — —
One-time adjustment to consolidated securitization
— — 3,682 0.01 — —
Unizan system conversion expense
Restructuring releases
— — 1,151 N.M. 6,666 0.02
Cumulative effect of change in accounting principle (2)
— — — — N/A (0.06 )
— — — — 13,112 0.04
Long-term debt extinguishment
— — — — (15,250 ) (0.04 )
N/A, not applicable.
(1) See Significant Factors Influencing Financial Performance discussion.
(2) Only reflected in the income statement on an after tax basis of $13.3 million.
(3) Pre-tax unless otherwise noted.
(4) After-tax.
(This section should be read in conjunction with Significant Factors 1-3 and 7.)
Our primary source of revenue is net interest income, which is the difference between interest income on earning assets (primarily loans, direct financing leases, and securities) and interest expense on funding sources (including interest bearing deposits and borrowings.) Earning asset balances and related funding, as well as changes in the levels of interest rates, impact net interest income. The difference between the average yield on earning assets and the average rate paid for interest bearing liabilities is the net interest spread. Non-interest bearing sources of funds, such as demand deposits and shareholders' equity, also support earning assets. The impact of the non-interest bearing sources of funds, often referred to as "free" funds, is captured in the net interest margin, which is calculated as net interest income divided by average earning assets. Given the "free" nature of non-interest bearing sources of funds, the net interest margin is generally higher than the net interest spread. Both the net interest spread and net interest margin are presented on a fully taxable equivalent basis, which means that tax-free interest income has been adjusted to a pre-tax equivalent income, assuming a 35% tax rate.
Table 4 shows changes in fully taxable equivalent interest income, interest expense, and net interest income due to volume and rate variances for major categories of earning assets and interest bearing liabilities. The change in interest income or expense not solely due to changes in volume or rates has been allocated in proportion to the absolute dollar amount of the change in volume and rate.
Table 4 — Change in Net Interest Income Due to Changes in Average Volume and Interest Rates (1)
Increase (Decrease) From Increase (Decrease) From
Previous Year Due To Previous Year Due To
Fully tax equivalent basis (2) Yield/ Yield/
(in millions of dollars) Volume Rate Total Volume Rate Total
Loans and direct financing leases
$ 118.6 $ 177.7 $ 296.3 $ 110.8 $ (75.7 ) $ 35.1
(29.8 ) 19.9 (9.9 ) 42.1 (24.7 ) 17.4
Other earning assets
3.8 6.2 10.0 1.4 (10.5 ) (9.1 )
Total interest income in earning assets
92.6 203.8 296.4 154.3 (110.9 ) 43.4
41.7 148.1 189.8 21.5 (52.7 ) (31.2 )
Short-term borrowings
(0.3 ) 21.6 21.3 (1.8 ) (0.9 ) (2.7 )
Federal Home Loan Bank advances
(4.7 ) 6.1 1.4 0.3 8.6 8.9
Subordinated notes and other long-term debt, including capital securities
(39.0 ) 66.4 27.4 21.6 (13.9 ) 7.7
Total interest expense in interest-bearing liabilities
(2.3 ) 242.2 239.9 41.6 (58.9 ) (17.3 )
Net interest income before funding cost adjustment
94.9 (38.4 ) 56.5 112.7 (52.0 ) 60.7
Funding cost adjustment
— (3.7 ) (3.7 ) — 3.7 3.7
$ 94.9 $ (42.1 ) $ 52.8 $ 112.7 $ (48.3 ) $ 64.4
(1) The change in interest rates due to both rate and volume has been allocated between the factors in proportion to the relationship of the absolute dollar amounts of the change in each.
2005 versus 2004 Performance
Fully taxable equivalent net interest income increased $52.8 million, or 6%, from 2004, reflecting the favorable impact of a $1.6 billion, or 6%, increase in average earning assets, as the fully taxable equivalent net interest margin remained unchanged at 3.33%.
The stability of the net interest margin reflected a combination of factors including the benefit of a shift in the earning asset mix from lower-yielding investments to higher-yielding loans as a result of decreasing the level of excess liquidity and redirecting part of the proceeds of securities sales to fund loan growth. In addition, the margin also benefited from an increase in non-interest bearing funds. These benefits were partially offset by the negative impact of intense loan and deposit price competition and share repurchases.
Fully taxable equivalent net interest income increased $64.4 million, or 7%, in 2004 from 2003. This reflected the benefit of a 13% increase in average earning assets, partially offset by the negative impact of an effective 5% decline in the net interest margin to 3.33% from 3.49%.
The net interest margin declined in the first half of 2004, primarily reflecting the sale of higher-margin automobile loans. Such sales totaled $1.4 billion in the first half of 2004 but only $0.2 billion in the second half of 2004. The decline in the net interest margin in the first half of the year also reflected, to a lesser degree, the growth in lower-margin investment securities, as well as the impact of rising interest rates. The net interest margin stabilized in the second half of the year as automobile loan sales diminished and lower cost deposit growth was strong.
AVERAGE BALANCE SHEET
Table 5 shows average annual balance sheets and net interest margin analysis for the last five years. It details average balances for total assets and liabilities, as well as shareholders' equity, and their various components, most notably loans and leases, deposits, and borrowings. It also shows the corresponding interest income or interest expense associated with each earning asset and interest bearing liability category along with the average rate, with the difference resulting in the net interest spread. The net interest spread plus the positive impact from the non-interest bearing funds represent the net interest margin.
Table 5 — Consolidated Average Balance Sheet and Net Interest Margin Analysis
Average Balances
Fully taxable equivalent basis (1)
(in millions of dollars) 2005 Amount % 2004 Amount % 2003 2002 2001
Interest bearing deposits in banks
$ 53 $ (13 ) (19.7 )% $ 66 $ 29 78.4 % $ 37 $ 33 $ 7
Trading account securities
207 102 97.1 105 91 N.M. 14 7 25
Federal funds sold and securities purchased under resale agreements
262 (57 ) (17.9 ) 319 232 N.M. 87 72 107
Loans held for sale
318 75 30.9 243 (321 ) (56.9 ) 564 322 360
Investment securities:
Taxable
3,683 (742 ) (16.8 ) 4,425 892 25.2 3,533 2,859 3,144
475 63 15.3 412 78 23.4 334 135 174
Total investment securities
Loans and leases: (3)
Middle market commercial and industrial (4)
4,817 361 8.1 4,456 (177 ) (3.8 ) 4,633 4,810 5,075
1,678 258 18.2 1,420 201 16.5 1,219 1,151 1,040
1,908 (14 ) (0.7 ) 1,922 122 6.8 1,800 1,670 1,522
Middle market commercial real estate
3,586 244 7.3 3,342 323 10.7 3,019 2,821 2,562
Small business commercial and industrial and commercial real estate
Total commercial
10,627 826 8.4 9,801 362 3.8 9,439 9,273 10,211
Automobile loans
2,043 (242 ) (10.6 ) 2,285 (975 ) (29.9 ) 3,260 2,744 N.M.
Automobile leases
2,422 230 10.5 2,192 769 54.0 1,423 452 N.M.
Automobile loans and leases
4,465 (12 ) (0.3 ) 4,477 (206 ) (4.4 ) 4,683 3,196 2,839
Residential mortgage
4,081 869 27.1 3,212 1,186 58.5 2,026 1,438 1,048
501 51 11.3 450 15 3.4 435 481 654
Total consumer
13,683 1,357 11.0 12,326 1,741 16.4 10,585 8,144 7,875
Total loans and leases
24,310 2,183 9.9 22,127 2,103 10.5 20,024 17,417 18,086
Allowance for loan and lease losses
(268 ) 30 (10.1 ) (298 ) 32 (9.7 ) (330 ) (344 ) (286 )
Net loans and leases
24,042 2,213 10.1 21,829 2,135 10.8 19,694 17,073 17,800
Total earning assets
Operating lease assets
372 (525 ) (58.5 ) 897 (800 ) (47.1 ) 1,697 2,602 2,970
Cash and due from banks
845 2 0.2 843 69 8.9 774 757 912
218 2 0.9 216 (2 ) (0.9 ) 218 293 736
All other assets
2,164 86 4.1 2,078 58 2.9 2,020 1,910 1,891
$ 32,639 $ 1,206 3.8 % $ 31,433 $ 2,461 8.5 % $ 28,972 $ 26,063 $ 28,126
Liabilities and Shareholders' Equity
Demand deposits — non-interest bearing
$ 3,379 $ 149 4.6 % $ 3,230 $ 150 4.9 % $ 3,080 $ 2,902 $ 3,304
Demand deposits — interest bearing
7,658 451 6.3 7,207 1,014 16.4 6,193 5,161 5,005
Savings and other domestic time deposits
3,155 (276 ) (8.0 ) 3,431 (31 ) (0.9 ) 3,462 3,583 4,381
Certificates of deposit less than $100,000
2,952 535 22.1 2,417 (285 ) (10.5 ) 2,702 3,619 4,980
Total core deposits
17,144 859 5.3 16,285 848 5.5 15,437 15,265 17,670
Domestic time deposits of $100,000 or more
1,292 427 49.4 865 63 7.9 802 851 1,280
Brokered time deposits and negotiable CDs
3,119 1,282 69.8 1,837 418 29.5 1,419 731 128
Deposits in foreign offices
457 (51 ) (10.0 ) 508 8 1.6 500 337 283
1,379 (31 ) (2.2 ) 1,410 (190 ) (11.9 ) 1,600 1,856 2,099
1,105 (166 ) (13.1 ) 1,271 13 1.0 1,258 279 19
Subordinated notes and other long-term debt
4,064 (1,315 ) (24.4 ) 5,379 820 18.0 4,559 3,335 3,411
Total interest bearing liabilities
25,181 856 3.5 24,325 1,830 8.1 22,495 19,752 21,586
All other liabilities
1,496 (8 ) (0.5 ) 1,504 303 25.2 1,201 1,170 905
2,583 209 8.8 2,374 178 8.1 2,196 2,239 2,331
Total Liabilities and Shareholders' Equity
Net interest rate spread
Impact of non-interest bearing funds on margin
Net Interest Margin
(1) Fully taxable equivalent (FTE) yields are calculated assuming a 35% tax rate.
(2) Loan and lease and deposit average rates include impact of applicable derivatives and non-deferrable fees.
(3) For purposes of this analysis non-accrual loans are reflected in the average balances of loans.
(4) 2005 reflects a net reclassification of $500 million from middle market commercial real estate to middle market commercial and industrial, on November 1, 2005.
Interest Income/Expense Average Rate (2)
$ 1.1 $ 0.7 $ 0.6 $ 0.8 $ 0.2 2.16 % 1.05 % 1.53 % 2.38 % 3.43 %
8.5 4.4 0.6 0.3 1.3 4.08 4.15 4.02 4.11 5.13
17.9 13.0 30.0 20.5 25.0 5.64 5.35 5.32 6.35 6.95
158.7 171.7 159.6 173.0 206.9 4.24 3.88 4.52 6.06 6.58
101.0 58.0 52.1 52.6 72.7 6.01 4.09 4.09 4.57 6.99
110.6 85.3 88.0 98.7 113.3 5.79 4.44 4.84 5.91 7.44
133.3 165.1 242.1 237.9 253.8 6.52 7.22 7.38 8.67 N.M
119.6 109.6 72.8 23.2 1.2 4.94 5.00 5.09 5.14 N.M
222.3 175.9 111.4 91.4 81.6 5.45 5.48 5.85 6.55 8.19
1,431.1 1,134.8 1,099.7 1,092.6 1,410.2 5.89 5.11 5.49 6.27 7.79
42.9 44.1 67.7 80.2 154.9 1.36 1.28 1.94 2.24 3.54
105.0 81.2 100.4 165.6 281.5 3.56 3.36 3.68 4.58 5.65
109.4 33.1 24.1 17.3 6.6 3.51 1.80 1.70 2.36 5.12
9.6 4.1 4.6 4.9 10.8 2.10 0.82 0.92 1.47 3.82
34.7 33.3 24.4 5.6 1.2 3.13 2.57 1.94 2.00 6.17
$ 975.8 $ 923.0 $ 858.7 $ 754.8 $ 721.6
AVERAGE BALANCE SHEET — LOANS, LEASES, AND OTHER EARNING ASSETS
Average total loans and leases increased $2.2 billion, or 10%, from 2004, reflecting growth in consumer loans and, to a lesser degree, growth in commercial loans. Average total consumer loans increased $1.4 billion, or 11%, from 2004 primarily due to a $0.9 billion, or 27%, increase in average residential mortgages as mortgage loan rates remained at attractive levels. Average home equity loans increased $0.4 billion, or 11%. Growth in both residential mortgages and home equity loans slowed over the second half of the year as rising short-term interest rates dampened customer demand.
Average total automobile loans decreased $0.2 billion, or 11%, from 2004 reflecting the sale of automobile loans, loan pay downs, and slowing production. Partially offsetting the decline in automobile loans was $0.2 billion, or 10%, growth in direct financing leases due to the continued migration from operating lease assets, which have not been originated since April 2002.
Average total commercial loans increased $0.8 billion, or 8%, from 2004. This reflected a $0.4 billion, or 8%, increase in middle market commercial and industrial (C&I) loans, a $0.2 billion, or 7%, increase in middle market commercial real estate (CRE) loans, and a $0.2 billion, or 11%, increase in average small business C&I and CRE loans.
Average total investment securities declined $0.7 billion, or 14%, from 2004. This decline reflected a combination of factors including lowering the level of excess liquidity, a decision to sell selected lower yielding securities, and partially funding loan growth with the proceeds from the sale of securities. We also made a decision in the fourth quarter of 2005 to reposition a segment of the portfolio to replace lower yield securities with higher yield securities. This resulted in $8.8 million of securities losses in the fourth quarter, but should position the portfolio for better future performance.
Growth in average total loans and leases accounted for most of the 13% increase in earning assets, though investment securities also increased as a portion of the proceeds from automobile loan sales was reinvested.
Average total loans and leases increased 11% from the prior year. Most of this reflected growth in average total consumer loans where the strong growth in residential mortgage and home equity loans was only partially offset by a decline in automobile loans, reflecting the sale of $1.5 billion of automobile loans in 2004. Average total commercial loans increased 4%, reflecting growth in middle market CRE and small business loans, partially offset by a decline in average middle market C&I loans.
AVERAGE BALANCE SHEET — DEPOSITS AND OTHER FUNDING
Average total core deposits in 2005 were $17.1 billion, up $0.9 billion, or 5%, from 2004, reflecting a $0.5 billion, or 22%, increase in certificates of deposit less than $100,000, a $0.5 billion, or 6%, increase in average interest bearing demand deposit accounts, primarily money market accounts, and a $0.1 billion, or 5%, increase in non-interest bearing deposits. These increases were partially offset by a $0.3 billion, or 8%, decline in savings and other domestic time deposits. With interest rates rising throughout the year, demand for certificates of deposit less than $100,000 increased as customers transferred funds from lower-rate savings and other domestic time deposits into higher fixed-rate term deposit accounts.
We use the non-core funding ratio (total liabilities less core deposits and accrued expenses and other liabilities divided by total assets) to measure the extent to which funding is dependent on wholesale deposits and borrowing sources. For 2005, the average non-core funding ratio was 35%, down from 36% in 2004. The average non-core funding ratio reached a peak of 38% in the first quarter of 2004 as strong loan growth outpaced core deposit growth. Subsequent loan sales, as well as successful core deposit growth initiatives, reduced average non-core funding requirements to 35% by the 2004 fourth quarter.
Average total deposits in 2004 increased 7% from the prior year, primarily reflecting 5% growth in average core deposits. Growth in interest bearing demand deposits, and to a lesser degree non-interest bearing deposits, accounted for virtually all of the growth in average core deposits, as average certificates of deposit (CDs) less than $100,000 declined. With interest rates near historical low levels, demand for CDs less than $100,000 greatly diminished in the first half of 2004. However, CDs less than $100,000 grew in the second half of the year as interest rates and customer demand for CDs less than $100,000 increased. In addition to growth in average core deposits, the increase in average total deposits also reflected a 29% increase in brokered time deposits and negotiable CDs, which, in comparison with rates on CDs less than $100,000, remained a relatively low cost of funds.
For 2004, the average non-core funding ratio was 36%, up from 35% in 2003.
(This section should be read in conjunction with Significant Factor 4 and the Credit Risk section.)
The provision for credit losses is the expense necessary to maintain the ALLL and the AULC at a level adequate to absorb our estimate of probable inherent credit losses in the loan and lease portfolio and the portfolio of unfunded loan commitments.
Provision expense for 2005 was $81.3 million, up $26.2 million, or 48%, from 2004. The increase in 2005 reflected a combination of factors including loan growth and higher levels of problem assets, most notably downgrades in certain commercial credits late in the fourth quarter. Given our highly quantitative loan loss reserve methodology, these downgrades required a meaningful increase in our ALLL. We believe these downgrades reflect weakness in certain credit situations rather than the beginning of a trend of material weakening in general credit quality.
Provision expense for 2004 was $55.1 million, down $108.9 million, or 66%, from the prior year. This reflected significant improvement in overall credit quality as reflected by a combination of factors, including lower net charge-offs and a single C&I recovery of $11.1 million in 2004, as well as the overall lower risk inherent in the loan and lease portfolio resulting from strategies to lower the overall risk profile of the balance sheet, partially offset by additional provision expense related to loan growth.
(This section should be read in conjunction with Significant Factors 1, 2, 3, and 7.)
Non-interest income for the three years ended December 31, 2005, was as follows:
Table 6 — Non-Interest Income
(in thousands of dollars) 2005 Amount % 2004 Amount % 2003
$ 167,834 $ (3,281 ) (1.9 )% $ 171,115 $ 3,275 2.0 % $ 167,840
77,405 9,995 14.8 67,410 5,761 9.3 61,649
53,619 (1,180 ) (2.2 ) 54,799 (3,045 ) (5.3 ) 57,844
44,348 2,774 6.7 41,574 128 0.3 41,446
41,710 9,414 29.1 32,296 (25,884 ) (44.5 ) 58,180
40,736 (1,561 ) (3.7 ) 42,297 (731 ) (1.7 ) 43,028
(8,055 ) (23,818 ) N.M. 15,763 10,505 N.M. 5,258
75,041 (17,006 ) (18.5 ) 92,047 988 1.1 91,059
Sub-total before operating lease income
492,638 (24,663 ) (4.8 ) 517,301 (9,003 ) (1.7 ) 526,304
138,433 (148,658 ) (51.8 ) 287,091 (202,607 ) (41.4 ) 489,698
Sub-total including operating lease income
631,071 (173,321 ) (21.5 ) 804,392 (211,610 ) (20.8 ) 1,016,002
— — — — (13,112 ) N.M. 13,112
$ 632,282 $ (186,316 ) (22.8 )% $ 818,598 $ (250,555 ) (23.4 )% $ 1,069,153
Table 7 details mortgage banking income and the net impact of MSR hedging activity. We record MSR temporary impairment valuation changes in mortgage banking income, whereas MSR hedge-related trading activity is recorded in other non-interest income, as well as in net interest income. Striking a mortgage banking income sub-total before MSR recoveries or impairments, provides a clearer understanding of the underlying trends in mortgage banking income associated with the primary business activities of origination, sales, and servicing. The net impact of MSR hedging analysis presents all of the MSR impairment valuation changes and related hedging activity.
Mortgage banking income and the net impact of MSR hedging activities for the three years ended December 31, 2005, was as follows:
Table 7 — Mortgage Banking Income and Net Impact of MSR Hedging
Mortgage Banking Income
$ 10,781 $ (1,596 ) (12.9 )% $ 12,377 $ (4,895 ) (28.3 )% $ 17,272
10,986 2,646 31.7 8,340 (15,267 ) (64.7 ) 23,607
Servicing fees
22,181 485 2.2 21,696 4,790 28.3 16,906
Amortization of capitalized servicing
(18,359 ) 660 (3.5 ) (19,019 ) 6,947 (26.8 ) (25,966 )
Other mortgage banking income
11,750 4,226 56.2 7,524 (3,880 ) (34.0 ) 11,404
MSR recovery
4,371 2,993 N.M. 1,378 (13,579 ) (90.8 ) 14,957
Total mortgage banking income
$ 41,710 $ 9,414 29.1 % $ 32,296 $ (25,884 ) (44.5 )% $ 58,180
Capitalized mortgage servicing rights (1)
$ 91,259 $ 14,152 18.4 % $ 77,107 $ 6,020 8.5 % $ 71,087
MSR allowance (1)
(404 ) 4,371 (91.5 ) (4,775 ) 1,378 (22.4 ) (6,153 )
Total mortgages serviced for others (1)
7,276,000 415,000 6.0 6,861,000 467,000 7.3 6,394,000
Net Impact of MSR Hedging
$ 4,371 $ 2,993 N.M. % $ 1,378 $ (13,579 ) (90.8 )% $ 14,957
Net trading losses related to MSR hedging (2)
(13,377 ) (7,867 ) N.M. (5,510 ) (5,510 ) N.M. —
Net interest income related to MSR hedging
1,688 238 16.4 1,450 1,450 N.M. —
Other MSR hedge activity (4)
— 4,492 N.M. (4,492 ) (4,492 ) N.M. —
Net impact of MSR hedging (3)
$ (7,318 ) $ (144 ) 2.0 % $ (7,174 ) $ (22,131 ) N.M. % $ 14,957
(1) At period end.
(2) Included in other non-interest income.
(3) The tables above exclude securities gains or losses related to the investment securities portfolio.
(4) Included in other mortgage banking income.
Non-interest income decreased $186.3 million, or 23%, from 2004 with $148.7 million of the decline reflecting the decrease in operating lease income. Of the remaining $37.7 million decline from 2004, the primary drivers were:
– $23.8 million decline in net securities gains, as the current year reflected $8.1 million of securities losses, primarily related to $8.8 million of securities losses due to the fourth quarter restructuring of a part of the securities portfolio, compared with $15.8 million of gains in 2004 taken to mitigate the net impact of the MSR impairment.
– $17.0 million, or 18%, decline in other income reflected a combination of factors including an increase in MSR hedge- related trading losses, lower income from automobile lease terminations, the $2.1 million write-off of an equity investment in the 2005 second quarter, lower investment banking income, and lower equity investment gains.
– $13.0 million decline in gains on sale of automobile loans as the year-ago period included $14.2 million of such gains.
– $3.3 million, or 2%, decline in service charges on deposit accounts, all driven by a decline in commercial service charges, reflecting a combination of lower activity and a preference by commercial customers to pay for services with higher compensating balances rather than fees as interest rates increased. Consumer service charges increased slightly reflecting higher activity-related personal service charges, mostly offset by lower maintenance fees on deposit accounts, as well as lower personal NSF and overdraft service charges.
– $1.6 million, or 4%, decline in bank owned life insurance income.
– $1.2 million, or 2%, decline in brokerage and insurance income, reflecting lower annuity sales.
– $10.0 million, or 15%, increase in trust services due to higher personal trust and mutual fund fees, reflecting a combination of higher market value of assets, as well as increased activity.
– $9.4 million, or 29%, increase in mortgage banking income, reflecting a $6.9 million increase in secondary marketing and other mortgage banking income, as well as a $3.0 million increase in MSR temporary impairment recoveries.
– $2.8 million, or 7%, increase in other service charges and fees, due to higher debit card fees, partially offset by lower bill pay fees as a result of a decision to eliminate fees for this service beginning in the 2004 fourth quarter.
Non-interest income for 2004 declined $250.6 million, or 23%, from 2003. Reflecting the run-off of the operating lease portfolio, operating lease income declined $202.6 million, or 41%, from 2003. Of the remaining $47.9 million decline from a year ago, the primary drivers were:
– $25.9 million decline in mortgage banking income reflected a combination of factors, all basically related to the lower level of mortgage originations as interest rates increased during 2004. Such factors included lower net secondary marketing revenue, as sales declined, and a 91% reduction in MSR recovery.
– $25.8 million decline in gains on the sale of automobile loans, reflecting both a decline in loan sales ($1.5 billion in 2004, $2.1 billion in 2003), as well as lower relative gains on the sales as the loans sold in 2003 were older and originated at higher rates.
– $13.1 million decline in gains on sale of branch offices, reflecting no such sales in 2004.
– $3.0 million decline in brokerage and insurance income primarily due to lower title insurance-related fees and reduced credit life insurance revenue, as well as a decline in annuity fee income due to a 7% decline in annuity sales volume.
– $10.5 million increase in securities gains primarily related to MSR temporary impairment hedging activity.
– $5.8 million increase in trust services income primarily due to higher personal trust income and proprietary mutual fund fees.
– $3.3 million increase in service charges on deposit accounts, reflecting higher NSF and overdraft fees, partially offset by lower personal and commercial account maintenance charges.
Non-Interest Expense
(This section should be read in conjunction with Significant Factors 1, 5, and 7.)
Non-interest expense for the three years ended December 31, 2005 was as follows:
Table 8 — Non-Interest Expense
$ 379,589 $ 3,321 0.9 % $ 376,268 $ 14,826 4.1 % $ 361,442
102,069 (7,469 ) (6.8 ) 109,538 23,717 27.6 85,821
481,658 (4,148 ) (0.9 ) 485,806 38,543 8.6 447,263
71,092 (4,849 ) (6.4 ) 75,941 13,460 21.5 62,481
74,638 2,523 3.5 72,115 5,997 9.1 66,118
63,124 (218 ) (0.3 ) 63,342 (2,579 ) (3.9 ) 65,921
34,569 (2,307 ) (6.3 ) 36,876 (5,572 ) (13.1 ) 42,448
28,077 1,588 6.0 26,489 (1,001 ) (3.6 ) 27,490
12,573 110 0.9 12,463 (546 ) (4.2 ) 13,009
829 12 1.5 817 1 0.1 816
76,236 (17,045 ) (18.3 ) 93,281 12,501 15.5 80,780
Sub-total before operating lease expense
861,444 (25,473 ) (2.9 ) 886,917 58,612 7.1 828,305
Sub-total including operating lease expense
969,820 (153,575 ) (13.7 ) 1,123,395 (98,180 ) (8.0 ) 1,221,575
Restructuring reserve releases — 1,151 N.M. (1,151 ) 5,515 (82.7 ) (6,666 )
$ 969,820 $ (152,424 ) (13.6 )% $ 1,122,244 $ (107,915 ) (8.8 )% $ 1,230,159
Non-interest expense decreased $152.4 million, or 14%, from 2004 with $128.1 million of the decline reflecting the decrease in operating lease expense. Of the remaining $24.3 million decline, the primary drivers were:
– $17.0 million, or 18%, decrease in other expense, reflecting $7.5 million of SEC/regulatory-related expenses in 2004, $5.8 million of costs related to investments in partnerships generating tax benefits in the year-ago period, and lower litigation related expense accruals and lower insurance costs in the current period.
– $4.8 million, or 6%, decline in net occupancy expense, as 2004 included a $7.8 million loss caused by property lease impairments, partially offset by lower rental income and higher depreciation expense in 2005.
– $4.1 million, or 1%, decline in personnel costs, mainly due to lower commission and benefit expense, partially offset by higher salaries and severance.
– $2.3 million, or 6%, decline in professional services, reflecting lower SEC/regulatory-related expense.
– $2.5 million, or 3%, increase in outside data processing and other services, reflecting mostly higher debit card processing expense and system conversion expense.
– $1.6 million, or 6%, increase in marketing expense.
– $1.2 million increase in the restructuring reserve charges line item, reflecting a restructuring reserve release in 2004 with no release in 2005.
SEC-related expenses and accruals, as well as expenses related to Unizan integration planning and systems conversions, contributed to the change in expense from 2004. Specifically, SEC/regulatory-related expenses and accruals totaled $3.7 million in 2005, down from $13.6 million in 2004. These expenses and accruals impacted the professional services and other expense categories. Unizan integration planning and systems conversion expenses totaled $0.7 million in 2005, down from $3.6 million in
2004. In addition to impacting the data processing and other services expense category, a portion of these expenses was also spread across various other expense categories.
Non-interest expense declined $107.9 million, or 9%, from 2003. Comparisons with prior-period results were significantly influenced by the decline in operating lease expense as previously noted. Operating lease expense declined $156.8 million, or 40%, from 2003. All other components of non-interest expense increased a net $48.9 million from 2003 reflecting:
– $38.5 million increase in personnel costs primarily related to higher retirement and insurance benefit expenses, and to a lesser degree, higher salaries.
– $13.5 million increase in net occupancy expense, reflecting a $7.8 million property lease impairment, as well as higher depreciation and lower rental income.
– $12.5 million increase in other expense impacted by SEC-related expenses and accruals. (See discussion below.)
– $6.0 million increase in outside data processing expenses, including Unizan-related expenses. (See discussion below.)
– $5.5 million decline in restructuring reserve releases, as such releases totaled $1.2 million in 2004, down from $6.7 million in 2003.
– $15.3 million related to the loss on the early extinguishment of debt in 2003.
– $5.6 million decline in professional services, primarily reflecting lower consulting expenses.
SEC-related expenses and accruals, as well as expenses related to Unizan integration planning and systems conversions, contributed to the change in expense from 2003. Specifically, SEC-related expenses and accruals totaled $13.6 million in 2004 compared with $6.9 million in 2003. These expenses and accruals impacted the professional services and other expense categories. Unizan integration planning and systems conversion expenses totaled $3.6 million in 2004. In addition to impacting the data processing and other services expense category, a portion of these expenses was also spread across various other expense categories.
(This section should be read in conjunction with Significant Factor 1 and the Market Risk section.)
Operating lease assets represent automobile leases originated before May 2002. This operating lease portfolio is running-off over time since all automobile lease originations after April 2002 have been recorded as direct financing leases and are reported in the automobile loan and lease category in earning assets. As a result, the non-interest income and non-interest expenses associated with the operating lease portfolio has declined.
Operating lease assets performance for the five years ended December 31, 2005, was as follows:
Table 9 — Operating Lease Performance
Balance Sheet:
Average operating lease assets outstanding
$ 372,132 $ 896,773 $ 1,696,535 $ 2,601,666 $ 2,969,902
Income Statement:
Net rental income
6,531 13,457 21,623 28,542 27,573
Recoveries — early terminations
5,383 6,432 9,431 13,079 9,535
Total operating lease income
Depreciation and residual losses at termination
99,342 216,445 350,550 463,783 506,267
Losses — early terminations
Total operating lease expense
Net earnings contribution
$ 30,057 $ 50,613 $ 96,428 $ 138,104 $ 133,107
Earnings ratios (1)
34.0 % 29.8 % 27.0 % 23.7 % 22.0 %
(1) As a percent of average operating lease assets.
Average operating lease assets in 2005 were $0.4 billion, down $0.5 billion, or 59% from a year-ago.
The net earnings contribution from operating leases was $30.1 million in 2005, down 41% from $50.6 million in 2004. Operating lease income, which totaled $138.4 million in 2005, and represented 22% of non-interest income, declined 52% from 2004, reflecting the decline in average operating leases. The majority of this decline was reflected in lower net rental income, down 53% from 2004. Lower fees and recoveries from early terminations also contributed to the decline in total operating lease income, but to a much lesser degree. Operating lease expense totaled $108.4 million for 2005, down 54% from a year ago, also reflecting the continued decline in operating lease assets, with the decline related to lower depreciation and residual losses at termination expenses.
The ratio of operating lease credit losses, net of recoveries, to average operating lease assets was 0.98% in 2005, down from 1.52% in 2004.
Average operating lease assets in 2004 declined 47% from the prior year. The net earnings contribution from operating leases was $50.6 million in 2004, down 48% from $96.4 million in 2003. Operating lease income, which totaled $287.1 million in 2004, and represented 35% of non-interest income, declined 41% from 2003 reflecting the decline in average operating leases. The majority of this decline was reflected in lower net rental income, down 42% from 2003. Lower fees and recoveries from early terminations also contributed to the decline in total operating lease income, but to a much lesser degree. Operating lease expense totaled $236.5 million, down 40% from a year ago, also reflecting the continued decline in operating lease assets, with the decline primarily related to lower depreciation and residual losses at termination expenses.
The ratio of operating lease asset credit losses to average operating lease assets, net of recoveries, was 1.52% in 2004, down from 1.96% in 2003.
Provision for Income Taxes
The provision for income taxes was $131.5 million in 2005, $153.7 million in 2004, and $138.3 million in 2003. The effective tax rate was 24.2%, 27.8%, and 26.4% in 2005, 2004, and 2003, respectively. The lower effective tax rate in 2005 compared with 2004 reflected an increasing benefit from tax-exempt income and a federal tax loss carryback, partially offset by the effect of the repatriation of foreign earnings. The higher effective tax rate in 2004 compared with 2003 reflected a reduction in tax benefits (credits) from investments in partnerships and the impact of higher non-deductible expenses.
As noted in our 2004 Form 10-K, the American Jobs Creation Act of 2004 introduced a special one-time dividends received deduction of 85% on the repatriation of certain foreign earnings to a U.S. taxpayer. During 2005, we had $109.4 million of foreign earnings eligible for repatriation, and in the third quarter of 2005, we received cash dividends in the amount of these previously undistributed foreign earnings. During the third quarter of 2005, our board of directors resolved to adopt our Domestic Reinvestment Plan, signed by our chairman, president, and chief executive officer. In the third quarter of 2005, income tax expense of $5.7 million, associated with the repatriation, was recorded. We have reinvested in the United States the cash dividend received through expenditures on infrastructure and capital investments with respect to the opening of new branches, qualified pension and 401(k) contributions, and funding of worker hiring, training, and other compensation.
The cost of qualifying investments in low income housing partnerships, along with the related tax credit, is recognized in the financial statements as a component of income taxes under the effective yield method. The cost of the investment in historic property partnerships is reported in non-interest expense and the related tax credit is recognized in the financial statements as a component of income taxes.
In the ordinary course of business, we operate in various taxing jurisdictions and are subject to income and non-income taxes. The effective tax rate is based in part on our interpretation of the relevant current tax laws. We believe the aggregate liabilities related to taxes are appropriately reflected in the consolidated financial statements. We review the appropriate tax treatment of all transactions taking into consideration statutory, judicial, and regulatory guidance in the context of our tax positions. In addition, we rely on various tax opinions, recent tax audits, and historical experience.
During the first quarter of 2005, the Internal Revenue Service commenced an audit of our consolidated federal income tax returns for tax years 2002 and 2003.
We expect the 2006 effective tax rate to increase to a more typical rate just below 30%. (See Note 18 of the Notes to Consolidated Financial Statements.)
RISK MANAGEMENT AND CAPITAL
Risk identification and monitoring are key elements in overall risk management. We believe the primary risk exposures are credit, market, liquidity, and operational risk. Credit risk is the risk of loss due to adverse changes in borrowers' ability to meet their financial obligations under agreed upon terms. Market risk represents the risk of loss due to changes in the market value of assets and liabilities due to changes in interest rates, exchange rates, residual values, and equity prices. Liquidity risk arises from the possibility that funds may not be available to satisfy current or future commitments based on external macro market issues, investor perception of financial strength, and events unrelated to the company such as war, terrorism, or financial institution market specific issues. Operational risk arises from the inherent day-to-day operations of the company that could result in losses due to human error, inadequate or failed internal systems and controls, and external events.
We follow a formal policy to identify, measure, and document the key risks facing the company, how those risks can be controlled or mitigated, and how we monitor the controls to ensure that they are effective. Our chief risk officer is responsible for ensuring that appropriate systems of controls are in place for managing and monitoring risk across the company. Potential risk concerns are shared with the board of directors, as appropriate. Our internal audit department performs ongoing independent reviews of the risk management process and ensures the adequacy of documentation. The results of these reviews are reported regularly to the audit committee of the board of directors.
Some of the more significant processes used to manage and control credit, market, liquidity, and operational risks are described in the following paragraphs.
Credit risk is the risk of loss due to adverse changes in borrowers' ability to meet their financial obligations under agreed upon terms. We are subject to credit risk in lending, trading, and investment activities. The nature and degree of credit risk is a function of the types of transactions, the structure of those transactions, and the parties involved. The majority of our credit risk is associated with lending activities, as the acceptance and management of credit risk is central to profitable lending. Credit risk is incidental to trading activities and represents a limited portion of the total risks associated with the investment portfolio. Credit risk is mitigated through a combination of credit policies and processes, and portfolio diversification.
The maximum level of credit exposure to individual commercial borrowers is limited by policy guidelines based on the risk of default associated with the credit facilities extended to each borrower or related group of borrowers. All authority to grant
commitments is delegated through the independent credit administration function and is monitored and regularly updated in a centralized database.
Concentration risk is managed via limits on loan type, geography, industry, loan quality factors, and country limits. We have focused on extending credit to commercial customers with existing or expandable relationships within our primary markets. As a result, shared national credit exposure declined in 2002 and 2003. The on-going sale of automobile loans is an example of the proactive management of concentration risk.
The checks and balances in the credit process and the independence of the credit administration and risk management functions are designed to accurately assess the level of credit risk being accepted, facilitate the early recognition of credit problems when they do occur, and to provide for effective problem asset management and resolution.
Credit Exposure Mix
(This section should be read in conjunction with Significant Factors 1 and 3.)
An overall corporate objective is to avoid undue portfolio concentrations. As shown in Table 10, at December 31, 2005, total credit exposure from the loan and lease portfolio was $24.7 billion. Of this amount, $13.6 billion, or 55%, represented total consumer loans and leases, $10.8 billion, or 44%, total commercial loans and leases, and $0.2 billion, or 1%, operating lease assets.
A specific portfolio concentration objective has been to reduce the relative level of total automobile exposure (the sum of automobile loans, automobile leases, securitized automobile loans, and operating lease assets) from 33% at the end of 2002. As shown in Table 10, such exposure was 18% at December 31, 2005.
In contrast, another specific portfolio concentration objective has been to increase the relative level of lower-risk residential mortgages and home equity loans. At December 31, 2005, such loans represented 36% of total credit exposure, up from 22% at the end of 2002.
Since the end of 2002, the level of total commercial loans and leases has remained relatively constant at 42%-44% of total credit exposure. However, middle market C&I loans declined to 19% at year-end 2004 from 22% at December 31, 2002, reflecting weak demand, but also a specific objective to reduce exposure to large individual credits, as well as a strategy to focus on commercial lending to customers with existing or potential relationships within our primary markets. During 2005, that concentration increased to 21%, reflecting increased customer demand. Conversely, since the end of 2002, small business loans increased to 9% from 8%, reflecting strategies to grow this important targeted business segment. (See Table 10.)
Table 10 — Loan and Lease Portfolio Composition
At December 31,
(in millions of dollars) 2005 2004 2003 2002 2001
Middle market commercial and industrial
$ 5,084 20.6 % $ 4,666 19.3 % $ 4,416 19.7 % $ 4,757 21.7 % $ 4,922 21.7 %
1,522 6.2 1,602 6.6 1,264 5.7