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Huntington Bancshares (NASDAQ:HBAN)

Q3 2011 Earnings Call

October 20, 2011 10:00 am ET

Executives

Stephen D. Steinour - Chairman of the Board, Chief Executive Officer, President, Member of Executive Committee, Chairman of The Huntington National Bank, Chief Executive Officer of The Huntington National Bank and President of The Huntington National Bank

Donald R. Kimble - Chief Financial Officer, Senior Executive Vice President and Treasurer

Daniel J. Neumeyer - Chief Credit Officer and Senior Executive Vice President

Jay Gould - Senior Vice President and Director of Investor Relations

Analysts

Craig Siegenthaler - Crédit Suisse AG, Research Division

David J. Long - Raymond James & Associates, Inc., Research Division

Ken A. Zerbe - Morgan Stanley, Research Division

Anthony R. Davis - Stifel, Nicolaus & Co., Inc., Research Division

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Andrew Marquardt - Evercore Partners Inc., Research Division

Erika Penala - Merrill Lynch

Paul J. Miller - FBR Capital Markets & Co., Research Division

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Brian Foran - Nomura Securities Co. Ltd., Research Division

Operator

Good morning. My name is Steve, and I will be a conference operator today. At this time, I would like to welcome everyone to the Huntington Bancshares Third Quarter Earnings Conference Call. [Operator Instructions] Thank you. Jay Gould, you may begin your conference.

Jay Gould

Thank you, Steve, and welcome. I'm Jay Gould, Director of Investor Relations for Huntington. Copies of the slides that we will be reviewing can be found on our website, huntington.com. This call is being recorded and will be available as a rebroadcast starting about 1 hour from the close. Please call the Investor Relations department at (614)480-5676 for more information on how to access these recordings or playback or should you have difficulty getting the slides.

Slides 2 through 4 note several aspects of the basis of today's presentation. I encourage you to read these, but let me point out one key disclosure. The presentation contains both GAAP and non-GAAP financial measures where we believe it is helpful to understanding Huntington's results of operations or our financial position. Where the non-GAAP financial measures are used, the comparable GAAP financial measure as well as a reconciliation to the comparable GAAP financial measure can be found in the slide presentation in its appendix in the earnings press release and the quarterly financial review and the quarterly performance discussion or in the related Form 8-K filed today, all of which can be found on our website.

Now turning to Slide 5. Today's discussion, including the Q&A period may contain forward-looking statements. Such statements are based on information and assumptions available at this time, and are subject to changes and risks and uncertainties, which may cause actual results to differ materially. We assume no obligation to update such statements. For a complete discussion of risks and uncertainties, please refer to this slide and material filed with the SEC, including our most recent forms 10-K, 10-Q and 8-K.

Now turning to today's presentation. As noted on Slide 6, participating today are Steve Steinour, Chairman, President and Chief Executive Officer; Don Kimble, Senior Executive Vice President and Chief Financial Officer; Dan Neumeyer, Senior Executive Vice President and Chief Credit Officer; also present is Nick Stanutz, Senior Executive Vice President and Head of Automobile, Finance and Commercial Real Estate.

Let's get started by turning to Slide 7. Steve?

Stephen D. Steinour

Welcome. I'll begin with the review of our third quarter performance highlights. After my overview time, we'll follow with this recap of our financial performance. Dan will provide an update on CRE. I'll then return with an update on our Fair Play and OCR, what we refer to as our Optimal Customer Relationship strategy and close with a discussion of our expectations for the next few quarters.

So turning to Slide 8, we reported net income of $143.4 million or $0.16 a share, essentially flat with the second quarter. Nevertheless, third-quarter results represented good progress against our strategic plan designed to improve long-term profitability and shareholder returns despite significant headwinds from the operating and interest rate environment.

We're clearly focused on the long-term and the level of returns we generate for the ROAs of the company. This quarter's ROA was 1.05%. We were still able to bring a solid 13% return on tangible common equity even as we took several steps to continue to reduce risk in both the liquidity during the quarter marked by political and economic uncertainty. Our $240.7 million in pretax, pre-provision income was in line with last quarter, and Don will provide additional details in a few minutes.

Fully taxable equivalent revenue increased $5.8 million or 1%. It's reflected a $3 million or 1% increase in net interest income. We saw several -- we saw average total loans growing at 8% annualized rate with C&I and indirect automobile loans with strong annualized growth rates of 9% and 17%, respectively.

Demand deposits grew a very strong 28% annualized rate. Consumer non-interest-bearing DDA has increased to the 21% annualized rates which was last seen, in large part, the success of Asterisk-Free Checking. Commercial DDA inflows where particularly strong and above normal growth levels and therefore, not likely to be repeated.

The net interest margin decreased 6 basis points to 3.34%. This was more of a decline than we outlined in last quarter's call as we were unwilling to add credit or duration risk during this time of record low rates. Don will have a more detailed walk forward in a few minutes.

Noninterest income increased $2.8 million or 1% reflecting a $15.5 million gain on sale of automobile -- from the automobile securitization. We view this as core earnings as we expect to use such securitizations from time to time to manage overall concentration risk of our auto portfolio. Several charges on deposit accounts increased -- service charges on deposit accounts increased $4.5 million or 7%, primarily driven by increased customer activity and new account growth.

Some were seeing that service charges on deposit revenues was back within 1% of a level seen a year ago. So I think that performance will compare favorably to most regional banks. But importantly, we did it without adding any new fees. We view this as very meaningful. Our customer growth, along with our ability to increase product penetration have virtually eliminated the financial impacts of an amendment to Reg E relating to certain overdraft fees plus our voluntary decision last year to reduce or eliminate a number of other deposit related fees and introduce it into this 24-Hour Grace. We believe our strategy to drive revenue by driving customer growth and product penetration is working.

Partially offsetting non-securitization gain and growth in the private service charges was an $11 million decline in Mortgage Banking income, primarily driven by a negative $13.9 million rate quarter change in net MSR valuation. The majority of the MSR decline occurred in the last 2 weeks of the quarter, concurrent with the Fed's implementation of Operation Twist.

Net interest expense increased $10.7 million or 2% with personnel costs up $8.3 million relating to the increase in salaries, severance and healthcare costs and a $5.7 million increase in outside data processing and other services as we converted to a new debit card processor.

Turning to Slide 9. Last quarter, we introduced some of our metrics around OCR with our consumer businesses. Earlier this quarter, we introduced similar metrics for our commercial businesses. These metrics are now part of our regular quarterly disclosures. In the third quarter, we continued to see strong results across both groups of customers.

Year-to-date, consumer checking account households were growing at nearly an 11% annualized rate. These new households are not just focused around a single service, we've been able to continue to grow our share of wallet with new and existing customers. Almost 73% of our consumer checking customers now have 4 or more products or services.

On the commercial side, we saw increase in growth with commercial relationships growing for the first 9 months at an 8.6% annualized rate. As expected, credit quality shows continued quarter improvement with the 7% decline in net charge-offs and 8% decline in nonaccrual loans. With our allowance for credit losses as a percentage of period end loans declined to 2.71% given the decline in nonaccrual loans. Our reserve coverage otherwise increased to 187%.

Internal capital generation remains strong. Our period-end tangible common equity ratio was stable at 8.22%, as tangible assets grew $1.9 billion and were temporarily rate inflated by the increased liquidity reflecting the proceeds of the automobile securitization.

Our Tier 1 common risk-based capital ratio increased to 10.17%, up 25 basis points. Our regulatory Tier 1 total risk-based capital ratios under the quarter 12.37% and 15.11%, respectively.

Turning to Slide 10. We continued to move forward with our positioning for long-term growth and increased profitability with the ongoing implementation of strategic initiatives designed to grow customers approved convenience and increased level while controlling costs. As I just mentioned, in September, we completed $1 billion automobile loan securitization. Our super prime and direct auto business have performed extraordinarily well over the cycle. We've seen significant growth in this business as our high level of customer service and commitment to the business has strengthened our relationships with target dealers. This allows us to take advantage of dislocations and expand into new markets. The growth trajectory of loan portfolio is such that we would likely reach our internal concentration limit within a year. By restarting our securitization program, we can maintain the size of the portfolio at appropriate levels while freeing up balance sheet capacity for continued expansion of that business.

As an example, shortly after the third quarter ended, we announced the expansion of our auto dealer finance business in the Wisconsin and Minnesota. Those markets are in a state of flux due to recently announced bank deals and this has allowed us to hire a seasoned team with multi-market knowledge for each state. We also continued to increase convenience and create the best experience for our customers. We have 23 Giant Eagle in-store branches opened and plan to have 28 opened by the end of the year. And while it's still early, the initial in-store branches are ahead of plan, en route to be on a path to break even before our goal of 24 months.

We also opened 3 traditional branches in the Detroit area. With the leadership team, we announced that Helga Houston will succeed Kevin Blakely as our Chief Risk Officer. Kevin is retiring at year end after almost 40 years in banking and 3 years with us here at Huntington. I'd like to just take just a moment to thank Kevin for his efforts over those 3 years and helping to turn the bank around and fundamentally strengthening, in very significant ways, our risk management capabilities and risk culture throughout the organization. And Helga has 30 years of diversified banking experience in risk management, business development and client relationships and we're excited to have her on board.

And finally, shortly after the quarter's end, Moody's upgraded the credit ratings of the bank and parent company level to A3 and BAA 1, respectively. We're not going to the details here but I do recommend you review Moody's press release. In particular, I call your attention to the comments on the results of stress testing all our real -- all of our real estate portfolios and views on our Auto portfolio.

Now let me turn the presentation over to Don to review the financial details. Don?

Donald R. Kimble

Thanks, Steve. Turning to Slide 11. It provides a summary of our quarterly earnings trends. Mainly the performance metrics will be discussed later in the presentation.

Let's turn to Slide 12, and it shows that our net income for the third quarter was $143.4 million or $0.16 per share. The $12.6 million decrease in the pretax income reflected the impacts of the $10.7 million to increase our noninterest expense, and the $7.8 million increase in provision expense, which were partially offset by a $3.1 million increase in net interest income and $2.8 million increase in noninterest income. I'll detail exchanges in subsequent slides.

On Slide 13, we show the trends in our revenues and our pretax, preprovision on the left hand side of the slide. The third quarter showed a slight decline in pretax, preprovision, most of which can be attributed to $11 million linked quarter increase in expenses, as well, detailed here, much of this increase was related to conversion cost of our debit card products and higher personnel costs driven by higher salary, severance and healthcare costs.

Slide 14, reflects the trends on our net interest income and margin. During the third quarter, our fully-taxable equivalent net interest income increased by $3 million reflecting a benefit of a $0.8 million increase in our average earning asset base, partially offset by the negative impact with 6 basis point decrease in net interest margin, the 3.34%. The 6 basis point decline in net interest margin reflected the impact of 4 primary factors. First with the 9 basis point reduction related to the impact of the extended low rate environment on loan yields.

In the quarterly financial review, we have provided the impact of swap on our commercial loan yields. This summary shows our total commercial loan yield declined by 4 basis points this past quarter after excluding the impact of interest rate swaps. This decline was primarily attributable -- attributed to $1 million or 2 basis points of lower income coming from nonaccrual loans. The offset of 2 basis point reduction coming from a lower benefit of investment securities and meaningfully higher level of liquidity on the balance sheet. We ended -- our proceeds from cash flows are 45 basis points lower in this past quarter than they were in the second quarter.

We also maintain a higher level of cash during the quarter given a heightened uncertainty surrounding the U.S. debt ceiling issue and the overall volatility that we experienced during the remainder of the quarter. We also had 1 basis point negative impact from the securitization of own loan yield in assets of 4% were replaced with investment securities and a 1.3% yield level. These negatives were partially offset by the benefit of 6 basis points from the reduction in deposit rates and the improvements in deposit mix.

Continuing on to Slide 15, we show the continued improvement in our deposit mix over the last 5 quarters. As we reduced the non-core and core time deposits to 23% from 29% of total average deposits. Perhaps more importantly, the increase in DDA balances over the same 5 quarters. At this quarter -- category, the increase is 34% -- or 30% of total average deposits. The improved deposit mix reflects the efforts of Fair Play banking on our consumer customers and our treasury management focus for our commercial businesses.

During the quarter, we also increased the focus on the deposit pricing and including plans that continue to drive the cost of funds lower to help offset the continued pressure from what we now view as an extended low rate interest environment. The impact of these efforts will be more visible in the fourth quarter results.

Turning to Slide 16. We showed a 2% increase in total core deposits. This increase reflected the efforts to drive core checking accounts household growth on both the consumer and commercial customer segments. On the consumer side, our year-to-date checking account households increase to less than 11% annualized rate. The strong growth in commercial deposit balances primarily reflect the results of our treasury management efforts and our OCR programs that deepen the relationships with our customers. Keep in mind, about $300 million of the commercial demand deposit growth reflected some temporary balances but will decline over the next couple of quarters.

Slide 17 shows trends in our loan and lease portfolio. Loan growth were broad based with every category of loans growing except commercial real estate, which continued to decline. Growth in the C&I area reflects the benefit of many of our initiatives including our focus on equipment finance, large corporate, business banking and middle market. Average automobile loans increase to the 17% annualized rate, including the impact of $1 billion securitization of automobile loans completed in September.

Residential mortgages also experienced growth of 5%, reflecting a continuation of a year-long trend of customer preference for shorter term fixed and/or variable mortgage products and -- which we are traditionally retaining on our balance sheet.

Slide 18, show the trend in our noninterest income, which increased $2.8 million or 1% from the prior quarter. This was driven by a $15.1 million increase in other income reflecting the $15.5 million gains in the sale of automobile securitization, which was also partially offset by a $6.8 million decline in SBA servicing income.

Service charges on deposit accounts followed by banking income increased $4.5 million or 7%, and $1 million or 3%, respectively, reflecting increased customer activity and new account growth. The service charge income is now within 1% of the year-ago level, reflecting the benefit of our strong household growth offsetting the impact of the amendment to Reg E and other Fair Play banking initiatives, implemented over the last several quarters. Electronic banking income is expected to decline approximately 50% in the fourth quarter as a result of the implementation of the Durbin Amendment on October 1.

Mortgage income declined by $11 million despite a 4% increase in origination. During the quarter, we recognized a $9.2 million net MSR loss. Originations over the last 2 years have resulted in recording a mortgage servicing asset on a lower cost-to-market basis. Given the low rate at the time and the expectation that rates would increase, along with the amortization of the asset, we made the decision not to hedge the value of this asset. During the last quarter, the net loss recognized on our lower cost-to-market asset was in excess of $11 million. Comparing the net $9.2 million loss recognized this quarter with the $4.7 million gain last quarter, the result in a reduction were changed in mortgage revenue of $14 million essentially offsetting the impact of the auto loan securitization.

This next slide is a summary of expense trends. Total expenses were up $10.7 million or 2% from the prior quarter. This reflected an $8.3 million increase in personnel costs, including the impact of severance cost, $2 million of higher healthcare costs, and also $1 million of low level asset from more origination cost deferral. Outside data processing and other services were also up this past quarter, and they're up $5.7 million, primarily related to the conversion costs associated our new debit card processor. Additional conversion costs are expected in the fourth quarter, which should be more than offset by a future economic benefit from this change.

Slide 20 reflects the trends on capital, virtually all the ratios improved over the prior quarter and reflecting the -- and strong internal capital generation and also capital relief from the auto securitization transaction. Our Tier 1 common ratio improved by 25 basis points to 10.17%. The TCE ratio was flat at 8.22%, reflecting the increase of our cash position at quarter end of $1.2 billion.

Slide 21, well, about the rationale for our $1 billion auto securitization this past quarter. As we see, this is an ongoing part of our auto business. Such securitizations provide 3 primary benefits. First, it helps manage our overall concentration of auto loans on our balance sheet. We see continued opportunities to grow our auto loan book faster than the rest of the loan portfolio. The securitization allows us to keep the concentration below 20% of our total loans book.

The structure also allows us to efficiently manage our capital attributed to this business. The residual interest that we sold with the structure represented 2.8% of the total loan balances. This compares with our 10% Tier 1 common ratio allowing us to benefit from this market leverage. And finally, securitization helps to provide funding source for this business allowing us to more appropriately price other funding sources.

So with that, let me turn the presentation over to Dan to review credit trends. Dan?

Daniel J. Neumeyer

Thanks, Don. Slide 22, provides an overview of our credit quality trends. The third quarter continued to show improvement in our credit quality metrics despite continued economic challenges. Normally, the net charge-off ratio fell from 1.01% annualized second quarter to 0.92% in the third quarter. This is the lowest level of charge-off since the third quarter of 2008. Well, both commercial and consumer loans contributed to this linked quarter improvement. While we expect continued improvement at our charge-off trends, the pace of the improvement will remain more modest given weak economic growth, relatively high unemployment and still unstable home values. Loans 90-plus days past due, delinquent and still accruing were basically flat quarter-over-quarter, up 1 basis point. We continue to have no commercial delinquencies in the 90-day-plus category.

The nonaccrual loans, nonperforming assets and Criticized asset ratios all showed continued improvement in the quarter, although the improvement brought somewhat by an uptick in common loan inflows. The allowance for loan loss and allowance for credit loss to loan ratios fell modestly to 2.61% and 2.71%, respectively. Nonetheless, coverage ratios increased due to lower nonaccrual loans and nonperforming assets.

Slide 23 shows trends in our nonaccrual loans and nonperforming assets. The chart on the left demonstrates the continued reduction in the level of both nonaccrual loans and nonperforming assets. Nonaccrual loans fell 8% in the quarter. With regard to nonaccrual inflows depicted on the right-hand chart, we once again saw a reduction in new inflows in the quarter after experiencing increased inflow in the second quarter. And as I mentioned in last quarter's discussion, we did not believe at that time that the second quarter inflow was the beginning of a trend rather simply, more indicative of the uneven nature of the commercial portfolio when individual credits can account for fairly large movements. This type of linked quarter lumpiness is not unexpected.

Slide 24 provides a reconciliation of our nonperforming asset flows. NPAs fell by 6% in the quarter, up from a 5% reduction in the prior quarter. The reduction in inflows was the primary driver, along with charge-offs and payments. The quarter also saw a lower level of loans return into accrual status, as well as a lower level of loan sales.

Turning to Slide 25, we provide a similar flow analysis at commercial Criticized loans. Over the past year, we have seen a consistent decline in the level of commercial Criticized loans. Although that trend continued with total Criticized loans down 4%, it was less of a decline than the 11% that we experienced in the prior quarter as current quarter Criticized inflows increased. The inflows consisted of both C&I and CRE loans, the rise of downgrade comprised a group of CRE loans that have a significant sponsor support and -- which we believe provides an opportunity to come to resolution and eventual upgrade. Several other large downgrades have impending events, which may also allow for upgrades in subsequent quarters.

Because of uncertain economic outlook, we continue to be very conservative in our early identification of problem loans, which allows for exercising a larger number of alternatives for restructuring and eventual upgrade. We do not believe that the vast majority of these early downgrades are at risk of further migration to nonaccrual status given the action plans and alternatives already developed. At this time, we believe the risk of loss on these new Criticized loans is negligible.

Moving to Slide 26, commercial loan delinquencies rose to 43 basis points from 32 basis points in the quarter -- in the prior quarter. While C&I delinquencies were flat quarter-over-quarter, CRE delinquencies were up and accounted for the entire increase. As mentioned earlier, we have no 90-day accruing delinquencies, which is consistent with prior quarters.

Slide 27 outlines consumer loan delinquencies, which were up modestly in the quarter in both 30- and 90-day categories. The results are consistent with typical seasonal patterns. The gray line in the chart on the left displays 30-day delinquencies excluding government-guaranteed loans and show the linked quarter uptick to 1.95% from 1.83%. This reflected modestly higher home equity and auto delinquencies partially offset by a slight decline in residential delinquencies. The accounting for the $1 billion auto securitization, consumer delinquencies are basically flat quarter-to-quarter. The 90-day increase shown on the chart on the right was more modest and saw delinquencies excluding government-guaranteed loans rising by 2 basis points in the quarter. Again, home equity and auto saw modest increases, while residential delinquencies experienced a small reduction. And again when we take into account the auto securitization, 90-day delinquencies were actually down 1 basis point or 2. Year-over-year results in both 30- and 90-day delinquencies continued to demonstrate improvement despite the ongoing challenges faced by [indiscernible].

So Slide 28, the loan-loss provision of $43.6 million was lower than net charge-offs by $47 million. The ACL to total loans was lower at 2.71% compared to 2.84% last quarter, although we believe this is very solid ratio given our continued improvement in the loans profile of the portfolio. Importantly, the ratio of ACL to nonaccrual loans actually increased to 187% from 181%. We believe that this coverage ratio should compare favorably to our peers.

Overall, we remain pleased with the collection of credit quality across the portfolio and expect continued improvements in subsequent quarters. Let me turn the presentation back to Steve.

Stephen D. Steinour

So as I mentioned in my opening comments, our Fair Play banking philosophy, Optimal Customer Relationship or OCR strategy has been resonating strongly in the market and driving accelerated new customer growth. Along with those new customers, we continue to benefit from higher retention rates as current customers feel an even stronger level of loyalty to Huntington. And as a result, related revenue is increasing.

This slide recaps trends in consumer checking account households. On Slide 29, first quarter 2011 growth was running at a 9.1% annualized rate. By the second quarter, year-to-date annualized growth increased to 9.8% and now for the first 9 months, this has increased even further to an annualized 10.8%. Throughout this period, several competitors announced they were adding fees or reducing product features to try to offset the lost revenue. Customers are clearly reacting positively to our strategy.

Now in addition we're selling more to all of our consumer households. For the third quarter, 72.8% of consumer checking account households use over 4 products or services, up from 71.3% in the second quarter and significantly higher than the 68.5% just a year ago.

We hear competitors are saying we're attracting low profitability consumers. And some of you who have told us, our competitors have even said they're glad to lose these customers. And we hope they continue to believe that. All we can say is that our related revenue is increasing with third quarter related revenue 5% higher than a year ago, and on an absolute basis above pre Reg E amendment levels. In a low interest rate environment, the earnings potential from a consumer demand deposit is less than in higher-rate environment. Perhaps that accounts for some of our competitors remarks. While we also note that loyalty matters. Loyalty matters. When rates rise and they will eventually, we have a fully developed, highly penetrated and extremely loyal customer base, which I believe is a -- will be a huge competitive advantage.

We're seeing similar trends in our commercial relationships as shown on Slide 30. I think it's important to note that our definition of commercial relationship is a business banking or commercial banking customer with a checking account relationship. A business with just a loan relationship is excluded. It's because we believe that checking account anchors a business relationship and creates the opportunity to increase cross-sell and ultimately total profitability, effectively, what we've done with our consumer household and how we look at it, and both of which benefit from our Optimal Customer Relationship strategy.

As shown on this slide, commercial relationships growth is also accelerating. That's growing 4.9% in 2010, commercial relationships for the first 9 months of this year grew at 8.6% annualized rate, a 75% improvement. For the third quarter, 29.2% of our commercial relationships utilized 4 or more products or services, up from 26.7% in the second quarter and significantly above the 23% penetration a year ago. And related revenue is also increasing. Related revenue for the third quarter was $176 million or up from $167 million in the second quarter, a 15.5% more than just a year ago. There are slides in the appendix that provide additional details.

And we believe we are winning the battle for retail and business customers in our markets. I'd like to use Slide 31 to recap our current thinking regarding our expectation for the next several quarters. Last quarter, we noted our concern that the economic environment was becoming increasingly uncertain. Third quarter events in Europe, Washington tail into debt ceiling, the Fed's comments about targeting the low interest rate environment through 2013, and their latest Operation Twist designed to bring down long-term interest rates relative to shorter interest rates have all increased economic uncertainty, and we see that uncertainty continuing.

As such, we expect the economic growth, if any, will be limited. But notwithstanding these pressures from the banking system, we believe our Fair Play banking philosophy and the value proposition of our products, which we've created for customers, sets us apart from the industry. That value proposition is driving our growth and it allows us to continue to invest in strategic actions that we believe will translate into long-term shareholder value.

With regards to net interest income, we expect to see modest growth. This will be driven by a modest loan growth and continue to mixing up our deposit base to lower cost deposits. These benefits are expected to be partially offset by modest net interest margin pressure reflecting the effect of extended low interest rate environment. But the current interest rate environment remains unchanged in 2012, it could cause our net interest margin to drop modestly below this level.

With regard to loan growth, we expect recent trends to continue with overall modest loan growth. This should reflect strong growth in auto loan off the September 30 base, meaningful growth in commercial and industrial loans, and modest growth in residential mortgages. These increases however, are expected to be partially offset by the continued decline in non-core commercial real estate loans.

Core deposits are expected to continue to grow, and has been our objective, we expect the absolute level of deposit growth to mirror the loan growth opportunities given the inability to invest excess deposit and attractive risk weighted returns. We anticipate fee income growth will continue to be mixed. We expect to see growth in key activities related to customer growth and improved mortgage banking income, excluding any MSR impact. We expect the implementation of the new interchange fee structure to reduce electronic banking income by approximately 50% or around $15 million from third quarter levels. Net interest expense is expected to decline modestly in the coming quarters with improved expense efficiencies. While strategic action like this quarter's debit conversion may cause short-term fluctuations. Nonaccrual loans and net charge-offs are expected to continue to decline.

In closing, we made a lot of progress in the third quarter. Much of this was settled on building our customer base, increasing product penetration and growing related revenue. The fourth quarter should see -- continue to see many of these same trends and with the additional headwinds of the interchange Tier reduction and margin pressure challenges given a low interest rate environment.

So thanks for your interest in Huntington. Steve will now take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Tony Davis with Stifel Nicolaus.

Anthony R. Davis - Stifel, Nicolaus & Co., Inc., Research Division

I just wondered, following the expansion during the New England, here and Wisconsin and Minnesota, how much broader of footprint do you envision for the auto business? Number 1. Number 2, our acquisition such as TCF, Gateway One deal are realistic growth option for you?

Stephen D. Steinour

We're essentially defined now in terms of our automobile geography could add a state or 2, but won't be a broad-based. And while we admire a lot of what TCF does and has done, we don't have plans to follow their expansion to national indirect lender.

Anthony R. Davis - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And one quick follow up, last quarter, it was so early, I guess, you really couldn't give us much color on how it was rolling out. But I wonder if you could talk a little bit more, Steve, about Asterisk-Free, how it has progressed relative to expectations and what you're seeing out there, I guess, in terms of competitor response today?

Stephen D. Steinour

Well, Asterisk-Free is part of our Fair Play philosophy and when we announced it about a year ago, Fair Play and that we were going to -- with 24-Hour Grace, and certain other fee give-ups in addition to Reg E, take a fee set back. And that we shared with the investment community just the fee give-ups and 24-Hour Grace would cost us $30 million. We're very pleased and we're well ahead of schedule to be back essentially flat year-over-year in the same timeframe. And Asterisk-Free, as you heard from those statistics from seeing the pages, it's accelerating our household growth. It's early as we said and as you acknowledged, but we like what we see so far in the mix. And we're continuing to get good cross-sell penetration in addition to the mix. But it's early, Tony, and so we're not sharing a lot more. We're not prepared to share a lot more until we have a better view of a sustainable run rate so we don't create a misperception.

Operator

Your next question comes from the line of Ken Zerbe with Morgan Stanley.

Ken A. Zerbe - Morgan Stanley, Research Division

With the resumption of your auto securitizations program, what does that imply about how aggressive you might be with writing new originations on the Auto side? I mean, should we think about this is as maybe a step down from super prime to prime, and securitized more of the prime stuff. And also at the end of the day, what I'm trying to figure out is how often would we start seeing these about $50 million gains from the securitizations?

Stephen D. Steinour

Ken, I'll do the credit in the first case. Don, why don't you talk about timing of the securitization, if you would, and Nick, kindly as well. But Ken, we don't anticipate changing our lending policy at all. And at this point, and there are no discussions to do so in the future. So we would expect to continue to generate super prime and we look at it weekly as we've shared with you in the past, and Nick and Tim, of course, are on it every day, all day.

Donald R. Kimble

Good. As far as the timing and the frequency of the securitization is that I would say that as a general expectation, we're probably looking at a couple of years. And some years, even some of you might have fewer, and the size of securitization is probably will be fairly similar to what we just did, but I wouldn't say that's an absolute guidance. But that's generally be met based on growth and balance sheet capacity and other funding considerations.

Daniel J. Neumeyer

Ken, we articulated the concentration limit for Auto. I think there's a little concern with just how much as a percentage of portfolio and the rate of growth as well, so -- and we shared internally, that 20% limit for total loans. And as we were requesting the $16 million, we had a further expansion on the horizon. We want to get ahead of it this quarter.

Stephen D. Steinour

And Ken, I would just add one comment, and that is we have a reputation that we have worked very hard to build in the marketplace. The dealers are very connected for a variety of reasons, and we want to stay very focused on what we are known to do and do really well. And that's where we want to continue to play in that space.

Ken A. Zerbe - Morgan Stanley, Research Division

Okay. Now it makes sense. And then just so -- one other question I had, on the MSR loss in the quarter, I may have missed this, but were you making any directional bets one way or the other? I think I heard a comment that you were not hedged on some pieces of it, but I wasn't sure if that's related to the MSR. Basically, I'm just wondering why you took more loss than, I guess, some of your peers.

Donald R. Kimble

Ken, good question, but we essentially have been including new mortgage loan originations on a lower cost for market basis over the last 2 years. And for that portion of the portfolio, we believe that interest rates over the long haul would increase from where they were before. And as a result of the amortization associated with that asset, we really didn't need to hedge it. And we monitored it but we didn't hedge it. And -- well, that we mark-to-market on that low common book really hit for the first time this past quarter and cost us $11 million of write-downs. So if you just look at the fair value portion of the MSR, we actual have a slight gain of about $2 million, which is consistent with what we've seen in previous quarters for that activity, but really it was a reflection of the low end rates coming down 90 basis points in early part of the quarter, as Steve referenced. But we had another 30 basis point drop in the last 2 weeks in the quarter, which costs $7 million of that impairment. And so it was more market-driven, onetime-related. We have taken a position to do a partial hedge of that asset going forward but it's a reflection of the strategy we've played up until now.

Stephen D. Steinour

So Ken, we originally moved to low comp because we thought it was more a conservative basis for covering the MSR. And we -- while we had it partially -- the low comp portion partially hedged was inadequate given the magnitude of the moves. As Don referenced, it's now more substantially hedged at this point going forward. But if you look at a 2-year continuum, we're way ahead having left it unhedged, but we're kicking ourselves, a bit, for missing this last couple of weeks in particular and the impact of it.

Operator

Your next question comes from the line of Kenneth Usdin with Jefferies.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

You guys have always done a very good job of continuing to focus on the long term in terms of investing in the footprint and continue -- in franchise, and you continue to put that forth. But I'm just wondering with acknowledging that the revenue environment is harder and the fourth quarter pressures and just the low rate environment, what else can you do in terms of that efficiency initiatives? Can you help to size it for us? Because it seems like the expense trajectory has continued to move up, and then notably, this quarter even on the comp line and the flat revenue quarter. So I'm just wondering, like, how do you -- how are you figuring through that balance and what structural things can you do to more than offset some of those investments that you're continuing to make?

Donald R. Kimble

Great question, Ken. And as far as the expenses, I just want to highlight a few things. There really are some unusual items in the quarter that drove that $11 million increase. We've talked about roughly a $6 million increase in outside processing and other services. A good portion of that relates to the conversion costs associated with our debit card efforts that we have going on. You've mentioned the increase in personnel cost of about $8 million linked quarter. We had $2 million increase in healthcare benefits, primarily related to 3 specific claims that were a large dollar amount that were outside the normal cost. We had $2 million of severance cost this quarter. And we had a host of other items of about $1 million each that I wouldn't suggest are quarterly occurring but they just ended up getting this past quarter. As far as the severance cost, it really was related to some continuous improvement efforts we have in place. We haven't targeted or size a specific initiative as to what we want to do as far as bringing down some of the expenses, but then, we do want to be able to focus on continuous improvement making sure that we're able to support investing in other initiatives where appropriate, but also keeping in mind that the impact of the economy over the next several quarters and the need to make sure that we're managing our expense base prudently and trying to keep that down. And as a result of the onetime items I talked about, our guidance was for expenses to be lower. But just as we referenced with the conversion costs, we expect those costs to continue into the fourth quarter, but we'll see benefits in future quarters from the impact of that conversion.

Stephen D. Steinour

Ken, we're very focused around the efficiency ratio and the expense level, and will be as we go forward.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Okay, got it. My second question, just in regard to the comment that we see in the press release about next year's margin potentially going below the low end of the 3.30% to 3.70%. I'm just wondering is that commentary more on a 2012 full year basis or about just "where it could get to in -- by the end of the year" type of comment. I'm just wondering. Just trying to understand the magnitude of compression that you think you might see as we look ahead to the next year or so.

Donald R. Kimble

It's first to point out that we do expect to see increases in net interest income even though the margin could show pressure. But the guidance as far as it could drop modestly or slightly below that long end of the guidance of the long-term -- into the guidance of 3.30%, more is a reflection of the fact that we're at a 3.34% for the current quarter. We think there will be continued pressure just because we don't want to extend the duration of our investment portfolio in this low rate environment and we want to make sure that we're managing that risk position appropriately.

Operator

Your next question comes from the line of Erika Penala with Bank of America.

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Steve, I know you alluded to this a bit on the call but we're quite aware of what the national banks are doing with regards to checking fees. But I guess, give us a sense on what your regional competitors are doing and whether or not they are being thrown for a loop by the Fair Play banking strategy?

Stephen D. Steinour

Erika, it's hard to project what they're doing. We've got a rearview mirror focus but I would say there's generally an effort to try to make up some of Reg E and Durbin. And you'd have to look at that bank by bank to see how they're doing it, and some of it is obvious and some it sort of -- what I call junk fees that are just getting added in like an ATM lookup -- balance lookup fee, things like that, none of which we're doing. And all of which sort of worked for us in this Fair Play philosophy much like that more commonly known, Bags Fly Free thing from Southwest, has resonated. And we expect that will continue and our growth in terms of competition, we believe it has some runway, undefined to have some runway yet. And we intend to be driving aggressively and try to foreshadow that in terms of the expectations of households and business unit growth in the near term.

Erika Penala - Merrill Lynch

And my follow-up question is around capital distribution. Do you get a sense that being part of the CCAR might limit your flexibility despite your strong lower Tier 1 common ratios with regards to near-term distribution?

Stephen D. Steinour

I think the regulatory environment and the Fed in particular, will look at the city bags as a class going forward. And being the midget in the room, it will still put us in the room. So we have -- we're going to go through the CCAR process, first time, which we outlined in the release. And unknown, prospective that they're going to conjecture on our part to take some kind of extended view comment right now, but our capital plan will be holistic in terms of uses of capital and we're trying to be efficient in our use as you saw at the auto securitization and our outlook for continued securitizations.

Erika Penala - Merrill Lynch

And have you disclosed, over the long term, where you'd like your total payout ratios to be taking into account those potential dividend increases and reinstatement of a buyback?

Stephen D. Steinour

We haven't disclosed that and it gets -- we have an organic growth dynamic, Erika, that we're also conscious of it. And at the moment, in some respects that, it appears to be accelerating, and we clearly want to continue that and fuel it. And then separately, from time to time, it could be an acquisition here and then -- so the standard uses of capital, we're working through all that, we'll work that through with the Fed and seek out process.

Operator

Your next question comes from the line of Craig Siegenthaler with Crédit Suisse.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Just looking at Slide 27, if you look at 30- to 89-day delinquencies x the guaranteed Ginnie Maes, delinquencies look to be basing and increasing. Then if I turn the slide over and look at even commercial Criticized loans inflows, they also kind of peaked up in the quarter. I know you gave a little bit of color on here but is your outlook for additional improvement in early stage credit quality, unique here is the next few quarters? And is this kind of in your terms, a seasonal hick up? I just kind of want to hear your outlook and some of these earlier signs?

Stephen D. Steinour

Yes, I think on the consumer side, I do think that as I've mentioned with this, you take the securitization out and we basically have flat and Reg E was down a little bit, home equity was up a little bit, so I don't -- we're not troubled at this point but this is a trend. We think that there'll be modest, continued improvement there. Similarly on the commercial side in terms of new inflows, obviously, I can't argue with the numbers. Inflows were up. However, there were a few events in the quarter that boost that number up higher than what we think is just normal downgrade activity and therefore, we're watching it closely, but feel that -- don't feel that, that is necessarily the beginning of a trend either. So we're on top of it. We feel pretty good about where we stand today and again on the commercial side, as I mentioned, we think there's negligible loss content in the new inflows.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Okay and then just a follow up, on the $1 billion auto securitization, I was wondering if you give us a few details on the structure. So I was kind of looking for what was the aggregate size of the equity tranche or the residual and then how much did you retain? And then also, under what circumstances would Huntington be able to consolidate some of the more senior tranches back on its balance sheet?

Donald R. Kimble

Great question. As far as securitization and whether the $1 billion, the residual interest, represented about $28 million of $1 billion. It was solid proof that we retained 0 of the securitization. Now we do have a mere pool of assets, which represents 5% of that balance that we do keep on our balance sheet. And it's more a response to be expected regulatory guidance as far as how to keep a similar retained interest but do not have any expectations at this point in time that, that would come back on the balance sheet. But we do have the opportunity once it narrows, I believe, to less than 5% of the outstanding balance as -- we might have an opportunity to repurchase, but that'll be a probably a minimis cleanup type of transaction.

Operator

Your next question comes from the line of Brian Foran with Nomura.

Brian Foran - Nomura Securities Co. Ltd., Research Division

Actually, I want to follow up to what you just said. So as -- if going forward, let's say, there was a big drop in the Manheim in one quarter that affected auto valuations. With the $15.5 million gain ever be subject to a true up our is it just once you booked the $15.5 million, it's booked and there's no risk of a true up going forward?

Donald R. Kimble

There is no risk there as far as that true up. We do have a servicing asset on our balance sheet but it's slight and we'll continue to value that over time but there is no risk to recapture that $15 million.

Brian Foran - Nomura Securities Co. Ltd., Research Division

And then I missed the beginning of the call, so if you already went over this, just stop me. But in the mortgage business, on origination and gain on sale, most of the banks seem to be down 20% on origination and almost flat on gain on sale margin, maybe, down a little bit year-over-year. Whereas -- as your business has shrunk more than that, is that -- was that a conscious decision or did you pull back from some geography or I guess why origination is down so much and gain on sale down further still?

Donald R. Kimble

On a year-over-year basis, we did have a much stronger origination volumes in the third and fourth quarter of last year that the 3 quarters this year are all fairly consistent. As far as originations ranked from $916 million in the second quarter, then $953 million in the third quarter. We did not change originations or locations or any other sources to the extent that our book today is primarily retail source. From our MROs, and it doesn't have anything in the way of our third-party sources that started the originations stream.

Brian Foran - Nomura Securities Co. Ltd., Research Division

Do that -- I mean, I guess does that imply that going forward, when refi goes up and down, we should expect your originations to not move as much? Or I guess, I'm not clear why originations will only be up whatever, it was 5% quarter-over-quarter when a lot of the other banks saw much bigger increases on a linked-quarter basis from the refi boom?

Donald R. Kimble

I'd say we're trying to maintain or manage our pricing there to -- that delivered the bottom line for us, but we probably will see a little less volatility than many of our peers from that perspective. Let's say, application volumes are up significantly and so we should see some higher origination volumes sort of fourth quarter based on that pipeline, but probably not as volatile as many of the peers might show.

Operator

Your next question comes from the line of Paul Miller of FBR.

Paul J. Miller - FBR Capital Markets & Co., Research Division

Yes, I also missed the beginning of the call, on your loan growth, can you talk about what industry -- if you already addressed this, I apologize guys. But on your loan growth, I know you're mainly -- Ohio or Michigan, what state is doing better versus the other? We hear Michigan is doing a lot better, and I think a lot of people expect it. And then what industry seems to be doing very well up in that area?

Daniel J. Neumeyer

This is Dan. I think the -- industry-wide, the new originations, really, are coming -- they're very much in line with what our typical portfolio distribution is. Manufacturing has served us very well. You're right. In Michigan, the auto suppliers have -- they're now healthy. We've had the fallout of the weak players and the survivors are quite strong, and so we've been very interested in that market. But if you look at the new originations compared to our overall portfolio, you would see very consistent numbers, and that would be whether you're looking at business banking, middle market or a large corporate, you would not see a big change. Now we are targeting certain business lines. Obviously, our large corporate has gotten up to speed over the last year. More activity in ABL, equipment finance and so forth, but we have good organic growth coming out of the middle market both in all our regions but I would say, Ohio and Michigan particularly.

Paul J. Miller - FBR Capital Markets & Co., Research Division

And then on the acquisition front, I believe that -- a couple of questions on, would you extend your footprint on the Auto. Is there any other areas you'll be -- you expand your footprint in? You've some other companies getting equipment leasing or other asset type classes. Is there any plans to expand in those areas?

Stephen D. Steinour

We have -- we made investments in late '09 and '10 in equipment finance and in large corporate. We're generally set at this point.

Paul J. Miller - FBR Capital Markets & Co., Research Division

What about -- you said -- and then on the M&A front, you haven't really -- a lot of people predicted a lot more M&A than we're seeing out there, and I think it's because the bid/ask prices are so wide apart. Are you getting any inquiries from small local guys that maybe want to get out of the business because of overregulation or is it still pretty quiet out there?

Stephen D. Steinour

We are getting inquiries. They don't quite phrase it that way but there may be a little bit of fatigue and angst about combination of reinvest challenge concentration risk issues, regulatory activity, including pending Dodd-Frank impacts. But it's -- there is a -- I would say that generally still a bid/ask call. And yes, we grow every quarter now what we used to grow a year in terms of consumer checking households. In 2010, we have 30,000 household growths, we're doing that in a quarter. And so we're going to keep driving the machine organically and hopefully, aggressively. And if something comes along that makes sense or right price, we'd look hard at it but it would have to be on our terms.

Operator

Your next question comes from the line of David Long with Raymond James.

David J. Long - Raymond James & Associates, Inc., Research Division

Looking at the third quarter, you had almost $2 billion of core CDs mature, and I was curious as to when in the quarter most of those may have matured, and then where did they go, what type of yields would they have been reinvested in?

Donald R. Kimble

Great question, David. We did have about $2 billion maturity, and the average rate on that maturity was 2.63%. It's interesting each of the month throughout the third quarter that average rate for that maturity bucket increased to where in the third quarter -- third month of the quarter September, it was over 3% kind of rate for that. So we really haven't seen a lot of benefit from that repricing in the third quarter that we will see in the fourth quarter. The average go-to rate for our CD originations was under 70 basis points. I think it was around a 165-basis-point range and tended to have around a 2-year average duration to it.

Stephen D. Steinour

As you look at the -- as you look forward, David, at sort of our cost of funds and compare us to other regionals, we have some pricing opportunity in the portfolio and some of that'll come through a change in mix and some of it is probably of an opportunity within the class.

David J. Long - Raymond James & Associates, Inc., Research Division

Right, so you had mentioned a formal initiative to lower the cost of funds and the impact would be more visible in the fourth quarter. On the initiative, is that separate from the CDs maturing? And then what may have been the impact in the third quarter versus what we can see in the fourth quarter?

Donald R. Kimble

I would say it's part of it. I'd say that later in the third quarter, we would implement it a little bit more later in some of the pricing strategy and so our go-to rates or our time deposits are lower now today than what they were throughout most of the third quarter. We've also had some similar efforts on the money market, deposit pricing. And toward the end of the quarter, we also started to see a lot more benefit from some of the commercial relationships bringing in some additional balances to their existing relationships, which help to drive the cost down. So I think it will be a part of the overall effort.

Operator

Your last question comes from the line of Andrew Marquardt from Evercore Partners.

Andrew Marquardt - Evercore Partners Inc., Research Division

Can you just help me understand on the credit quality, NPAs and net charge-offs should continue to decline, but how should we think about provisions, should that match charge-offs from here on or should we continue to see reserve release?

Stephen D. Steinour

I think we've pretty much if you look at our level of provision, that's pretty much at a kind of core level, what we would expect to see on an ongoing basis. It may move quarter-over-quarter a little bit, but I think we're generally in the range. And I guess that there might be a little bit of movement but that's based on quarterly developments. But...

Andrew Marquardt - Evercore Partners Inc., Research Division

But does that imply, actually maybe, if charge-offs can see the decline that reserves would actually build from here?

Stephen D. Steinour

Well, I think right now we have very strong coverage levels and the portfolio is improving. So I wouldn't necessarily see a build, no. But we have a lot of -- when we have periods of a lot of volatility like the third quarter, we talked -- I mentioned briefly, concerns with Europe, concerns with change in confidence as a consequence of the debt issues in Washington that we're going to be prudent. We're going to be conservative with our views on risk.

Andrew Marquardt - Evercore Partners Inc., Research Division

Got it. That's helpful.

Stephen D. Steinour

Thanks Andrew.

Andrew Marquardt - Evercore Partners Inc., Research Division

And then lastly, pretax, pre-provision earnings, any sense of how that should trend from here. It came in a little bit lower than what you were looking for obviously. Last quarter, should it hold at kind of the $240 million level or should it kind of continue to drift down because of the Durbin and other things near term?

Donald R. Kimble

I would say that it's a little lower than what we probably would have thought coming into the quarter but it's more reflective of some of the costs that we have talked, whether it's a conversion cost or some of the other items that caused that to be slightly lower than expectation. As far as the impact, what we talked about, our guidance shows that we do expect the Durbin impact to have about a $16 million reduction to fee income that we think offsetting that will be continued modest improvement in net interest income. We think we'll see continued improvement in other fee categories like deposit service charges were up $4.5 million this past quarter. And we think the expense levels absent the conversion type of cost will return to more normal levels. So we think that those efforts will offset the impact of Durbin.

Andrew Marquardt - Evercore Partners Inc., Research Division

So this is probably a good run rate for now until kind of the macro improves, is that fair?

Stephen D. Steinour

I'd say, generally that's in line with expectations, but just because of the challenge that you talked about whether the macro economic outlook or interest rate environment overall.

Jay Gould

Okay. This is Jay Gould. I want to thank you all for participating in the call today. If you have further questions, feel free to call me as you always do. We will see you next quarter. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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