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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

Todd Beekman - Director of Investor Relations

Analysts

Craig Siegenthaler - Crédit Suisse AG, Research Division

Jon G. Arfstrom - RBC Capital Markets, LLC, Research Division

Ken A. Zerbe - Morgan Stanley, Research Division

Stephen Scinicariello - UBS Investment Bank, Research Division

Christopher M. Mutascio - Stifel, Nicolaus & Co., Inc., Research Division

Leanne Erika Penala - BofA Merrill Lynch, Research Division

R. Scott Siefers - Sandler O'Neill + Partners, L.P., Research Division

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

Huntington Bancshares (HBAN) Q4 2011 Earnings Call January 19, 2012 10:00 AM ET

Operator

Good morning. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to the Huntington Bancshares Fourth Quarter Earnings Conference Call. [Operator Instructions]

I'll now turn the call over to Todd Beekman, Director of Investor Relations. Please go ahead.

Todd Beekman

Thanks, Steve. Welcome. I'm Todd Beekman, Director of Investor Relations for Huntington Banc. Copies of the slides that we will be reviewing can be found on our website at www.huntington.com. This call is being recorded and will be available for rebroadcast starting about an hour after the close of the call. Please call Investor Relations department at (614) 480-5676 for more information on how to access the recording of playback or should you have difficulty getting copies of the slides.

Slides 2 and 3 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 understand Huntington's results of operations or financial position. Where non-GAAP financial measures are used, the comparable GAAP financial measure as well as the reconciliation of the comparable GAAP financial measure can be found in the slide presentation, its appendix, in the earnings press release, in the quarterly financial review, the quarterly performance discussion or in the latest 8-K filed today, all of which can be found on our website.

Turning to Slide 4. 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 change, risks and uncertainties, which may cause the results to differ materially. We assume no obligation to update such statements. For a complete discussion of risks and uncertainties, please refer to the slide and material we filed with SEC, including our 10-K, 10-Q and 8-K filings.

Now turning to today's presentation. As noted on Slide 5, participating in today's call are Steve Steinour, Chairman, President and CEO; Don Kimble, Senior Executive Vice President and CFO; Dan Neumeyer, Senior Executive Vice President and Chief Credit Officer.

Turning to Slide 6. Steve?

Stephen D. Steinour

Thank you, Todd. Welcome, everyone. I'll begin with the review of our fourth quarter performance highlights. After my overview, Don will follow with his recap of our financial performance. Dan will provide an update on credit. I will then return with an update on our Fair Play and OCR or Optimal Customer Relationship strategy and close with the discussion of our expectations for this year.

Before we get started, for those of you who are regulars on this call, there's a notable absence on today's call. After over a decade of service to Huntington in over 30 years in the field of Investor Relations, Jay Gould had decided to retire. He will be with the company until the middle of the year. I wanted to take a moment to thank Jay for his counsel during what have been some turbulent times and his tireless efforts in communicating the Huntington message. In particular, Jay helped Don and I provide insight and industry-leading levels of disclosure about Huntington over the last several years.

Now getting to the topic at hand and turning to Slide 7. We report a net income of $126.9 million or $0.14 per share, up 3% from a year ago but down 12% or $0.02 from the third quarter. There were 2 factors that impacted this quarter's results. First was the anticipated impact of the reduction of electronic banking income due to the implementation of the Durbin Amendment related to a debit card fee reduction. The total impact for the quarter was $17.3 million.

The second was the absence of an automobile loan securitization gain as the third quarter included a $15.5 million gain. As we noted last quarter, we intend to use automobile loan securitizations to manage our overall balance sheet risk exposure to automobile loans and expect to have such securitization gains from time to time but not likely every quarter. In that regard, at the end of the year, we transferred $1.3 billion of automobile loans to held for sale in anticipation of another securitization during the first half of 2012.

The combined impact was nearly $33 million, which accounted for more than $20.8 million or a 3% decrease in total fully taxable equivalent revenue. This total revenue decline included a $29.2 million or 11% decline in noninterest income. This reflected the impact of the 2 items I mentioned previously.

Revenue was also negatively impacted by a $6.4 million Visa-related derivative loss. These negatives were partially offset by an $11.3 million increase in mortgage banking income.

Fully taxable equivalent net interest income increased $8.4 million or 2%. For the quarter, our NIM increased by 4 basis points as we continue to lower deposit and other funding cost. We also had a 2% annualized growth in average total loans. Now the total loan growth rate is partially understated due to the third quarter's $1 billion automobile loan securitization.

Another highlight for the quarter was strong commercial growth -- loan growth, which increased at a 16% annualized rate. Average total core deposits increased at a 14% annualized growth rate with the mix continuing its shift to lower-cost demand deposits. Total demand deposits increased $2 billion. This reflected core organic growth as well as $600 million of what we consider as short-term commercial deposits that were previously collateralized short-term borrowings.

Noninterest expense declined $8.8 million or 2% as the quarter included a $9.7 million gain on the extinguishment of debt related to our trust exchange.

Turning to Slide 8. Our OCR methodology continued to deliver strong success. On the consumer side, we finished the year well above our initial target of 7.5% growth as consumer checking account households grew 10.3%. This is nearly 4x the rate of growth in 2009 and more than 50% higher than last year. More importantly, our cross-sell performance also continued to improve. At the end of the year, 73.5% of our consumer checking account households have over 4 products or services. This compares with 69.4% a year ago.

We are seeing similar success on the commercial side. Growth in commercial relationships was 8.4% for the full year. We're also winning the cross-sell game here. At the end of the year, 31.4% of our commercial relationships used 4 products or services -- 4 or more products or services, up from 24.2% a year ago.

Our Fair Play philosophy, coupled with an increasing effective OCR focus while positively impacting current period results, is also positioning us for better long-term performance. We all know that in today's low interest rate environment that the value of deposits could be at an all-time low. What Fair Play combined with OCR is giving us is not only higher customer growth and cross-sell revenue, but increased customer loyalty. When rates eventually rise, we believe our demand deposits will prove to be very sticky.

Turning to credit quality. Our metrics continued to improve as expected. Net charge-offs declined 7% to an annualized rate of 85 basis points. Nonaccrual loans dropped 4%. Our allowance for credit losses as a percentage of nonaccrual loans remained at 187%, which we believe will continue to compare favorably to our peers.

Our capital position remains strong. Our tangible common equity ratio rose 8 basis points to 8.3%. Our regulatory capital ratios remained strong but declined from the third quarter due to an increase in risk-weighted assets.

While not noted on this slide, our fourth quarter pretax preprovision earnings were $227.8 million, down $12.8 million from the third quarter. The details can be found on Slide 37 in the appendix. But going forward, we no longer plan to report pretax preprovision metrics. We consider our provision expense now to be at levels consistent with our longer-term expectations and believe that it's time to return to tracking net income as the primary metric of overall financial performance.

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

Donald R. Kimble

Thanks, Steve. Slide 9 provides a summary of our quarterly earnings trends. Many of the performance metrics will be discussed later in the presentation. But turning to Slide 10, our net income for the third quarter was $126.9 million or $0.14 per share, down from $0.16 per share from last quarter. The primary driver for this decrease was a $29.2 million or 11% decrease in noninterest income, partially offset by an $8.8 million or 2% decrease in noninterest expense and an $8.5 million or 2% increase in net interest income. The decrease in noninterest income reflected the $17.3 million impact from the Durbin Amendment that Steve mentioned earlier.

Slide 11 depicts the trends of our net interest income and margin. During the fourth quarter, our fully taxable equivalent net interest income increased $8.4 million, reflecting the benefit of a $0.4 billion increase to our average earnings assets and a 4-basis point increase in our net interest margin to 3.38%. The 4-basis point increase in our net interest margin reflected the impact of 4 primary factors. First, a 15-basis point increase from a reduction in deposit rates and improvement in deposit mix, resulting in a 16-basis point reduction in the average cost of funds. The benefit was partially offset by a 4-basis point reduction related to the impact of the extended low rate environment on loan yields. Also, a 4-basis point reduction related to the items -- other items, including last quarter's auto securitization. And finally, a 3-basis point reduction coming from the yields on investment securities and the continuation of the high liquidity levels.

Continuing on to Slide 12. We have shown continued improvement on our deposit mix over the last 5 quarters as we reduced our noncore and core CDs from 21% -- to 21% from 28% of total average deposits. Perhaps more important was the increase in DDA balances over the same 5-quarter period as this category has increased to 38% from 30% of total average deposits. The improved deposit mix reflects the efforts of Fair Play banking for the consumer category and our treasury management focus for our commercial businesses.

Turning to Slide 13. We showed a $1.4 billion or 3% increase in average core deposits. This increase reflected the efforts to drive core checking household growth on both the consumer and commercial side. On the consumer side, our checking account households increased at 10.3% and consumer noninterest-bearing demand deposits grew 35% from the fourth quarter of 2010. We have shown significant progress in transitioning our liabilities from what was a thrift-like deposit mix toward levels of high performing commercial banks. The strong growth in commercial deposits primarily reflected the results of our treasury management efforts and our OCR program to deepen the relationships with our customers. About $600 million of the commercial growth reflect the movement of previously collateralized short-term borrowings and the demand deposits. These deposits are of a similar nature to the $300 million to $400 million of commercial deposits we called out last quarter, which we view as temporary balances and expect to decline over the next several quarters.

Slide 14 shows trends in our loan and lease portfolio. Average total loans and leases increased $0.2 billion or 1% from the 2011 third quarter, primarily reflecting $0.6 billion or 4% growth in average commercial industrial loans, reflecting increased activity from multiple business lines, including equipment finance, large corporate and dealer services. C&I utilization rates were down slightly from the prior quarter due to an increase in unfunded loan commitments. This was partially offset by a $0.6 billion or 9% decline in the average automobile loans. The decline in the fourth quarter average balances reflected a full quarter's impact of $1 billion securitization completed on September 15. On December 31, as Steve mentioned earlier, we reclassified $1.3 billion of auto loans to loans held for sale, which is roughly 1 to 2 quarters of origination as we plan to complete another securitization in the first half of 2012.

Slide 15 shows the trends in our noninterest income, which decreased $29.2 million or 11% from the prior quarter. This decline reflected $16.2 million of lower gains on loan sales as the prior quarter included the $15.5 million gain associated with last quarter’s auto loan securitization. In addition, the current quarter was negatively impacted by a $14.6 million or 44% decline on electronic banking income, primarily driven by the $17.3 million reduction related to implementing the lower debit card interchange fee structure mandated by the Durbin Amendment. These decreases were partially offset by an $11.3 million or 88% increase in mortgage banking income, driven by a $5.6 million increase in origination and secondary marketing income, as well as a $5.2 million reduction in the net mortgage servicing rights or MSR loss for the quarter. The $4 million MSR loss recognized in the current quarter primarily reflects the model value adjustments that allowed us to show an accelerated prepayment expectation. Other income included a $7.5 million increase in mezzanine investment gains that were partially offset by the $6.4 million negative impact related to an increase on the liability associated with the sale of our Visa Class B shares in 2009. While many of our market-based fee income categories were down from the third quarter, several of these categories, including brokerage and capital markets, were up double-digit growth rates over the prior year.

The next slide is a summary of expense trends. Noninterest expense decreased by $8.8 million or 2%. This included the benefit of the $9.7 million gain on the early extinguishment of debt related to our trust preferred securities exchange, a $5.9 million seasonal decrease in marketing expenses. But these reductions were partially offset by a $3.8 million or 8% increase in outside data processing and other services, primarily due to the cost associated with the conversion to a new debit card processor. These costs should not continue into the future quarters. We also had $3.6 million or 16% increase in equipment expenses, partially driven by accelerated depreciation associated with the planned consolidation of 29 branches in the first quarter of 2012.

Slide 17 reflects the trends in capital. Our tangible common equity ratio increased to 8.3%, up from 8.22% at the end of the prior quarter. The Tier 1 common risk-based capital ratio at December 31 was 10%, down from 10.17% at the end of the prior quarter and was negatively impacted by the increase in our risk-weighted assets.

For 2012, we are part of the Federal Reserve's Capital Plan Review or CapPR stress test process and made our capital plan submission earlier this month. While we can give no assurances as to the outcome or any specific details in the interactions with the regulators, we believe we have a strong capital position.

Let met turn the presentation over to Dan Neumeyer to review the credit terms. Dan?

Daniel J. Neumeyer

Thanks, Don. Slide 18 provides an overview of our credit quality trends. The third quarter continued to show improvement in our credit quality metrics despite continued economic challenges. Notably, the net charge-off ratio fell from 92 basis points annualized in the third quarter to 85 basis points annualized in the fourth quarter. This represented the 8th consecutive quarter of lower net charge-offs. Both commercial and consumer loan charge-offs were lower in the quarter. We would expect the continued improvement in net charge-offs will be realized in 2012 although the pace of improvement will likely be more modest as we approach normal levels.

Loans of 90-plus days, delinquent and accruing were up modestly in the quarter from 16 basis points to 19 basis points. As we saw with the 30-day category last quarter, this reflected normal seasonal patterns but remained lower than the fourth quarter of 2010. We continue to have no commercial delinquencies in the 90-day plus category. The nonaccrual loan ratio of 1.39% as well as the nonperforming asset and criticized asset ratios all showed modest but continuing improvement in the quarter. The allowance for loan and lease loss and allowance for credit loss to loan ratios fell modestly to 2.48% and 2.6% from 2.61% and 2.71%, respectively. The coverage ratios remain very strong, however, as lower allowance levels were offset with lower nonaccruing loans and nonperforming assets. The allowance for loan loss and the allowance for credit loss to nonperformers were basically flat quarter-over-quarter. We believe that the combination of the net charge-off ratio, the nonaccrual loan ratio and the allowance for credit loss to nonperformer coverage ratios continue to be best in class among our peers.

Slide 19 shows the 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 and nonperforming assets fell 4% in the quarter. With regard to nonaccrual inflows depicted on the right-hand slide, we saw an increase in new inflows in the quarter although still lower than the inflows experienced in the first and second quarters of the year. The general trend of inflows throughout the year continued to show improvement. However, the activity tends to be uneven from quarter-to-quarter. Commercial nonperformers were down in the quarter while home equity and residential mortgages saw a slight increase. Both home equity and residential mortgage nonaccrual loans have been written down to net realizable values less anticipated selling cost which substantially limit any significant future risk of loss.

Slide 20 provides the reconciliation of our nonperforming asset flows. Nonperforming assets fell by 4% in the quarter compared to a 6% reduction in the prior quarter. Although inflows were up in the quarter, payments and loans returning to accrual status were up as well and along with the impact of charge-offs and modest loan sales, the overall level of nonperforming assets declined.

Turning to Slide 21, we provide a similar flow analysis of commercial criticized loans. The inflow of new criticized loans was lower than the fourth quarter compared to the third quarter although the inflows remained elevated given the still relatively weak economic conditions. In combination with an increase in paydowns, the result was a 6% reduction in criticized loans compared to the 4% reduction experienced in the fourth -- in the third quarter.

Moving to Slide 22. Commercial loan delinquencies fell from 43 basis points in the third quarter to 27 basis points in the fourth quarter. Both commercial and industrial and commercial real estate had lower delinquency levels in the quarter. We continue to have no 90-day-plus commercial accruing delinquencies, which is consistent with prior quarters and as a result of our early identification and treatment of problem loans.

Slide 23 outlines consumer loan delinquencies, which were up modestly in the third quarter in both the 30- and 90-day categories. This is consistent with typical seasonal patterns. Year-over-year performance continued to show a positive trend in both the 30- and 90-day categories. The black line on the left side of the slide exclude government-guaranteed loans and shows an uptick from 1.95% to 2.06% quarter-over-quarter. Residential delinquencies accounted for the majority of the increase. On the right side, you see the 90-day delinquencies rose from 32 basis points to 40 basis points. The dotted line shows the estimated impact of the third quarter $1 billion asset securitization and the fourth quarter movement of $1.3 billion of auto loans to held for sale. This estimate allows for an analysis of delinquencies on a comparable basis and shows a less pronounced increase in delinquencies and a greater pace of improvement on a year-over-year basis.

Reviewing Slide 24. The loan loss provision of $45.3 million was slightly higher than the prior quarter and was less than net charge-offs by $38.6 million. The ratio of the ACL to the nonaccrual loans remains steady at 187%, representing a very healthy coverage level. The ACL to loans is lower at 2.6% compared to 2.71% last quarter, although we believe this to be a very solid ratio given the continued improvement in the risk of the portfolio.

Overall, despite continued challenges presented by the economic environment, we remain pleased with the direction of credit quality across the portfolio and expect continued improvement in 2012. We believe that the combination of our performance metrics again puts us in a very good position relative to our peer group.

Now let me turn the presentation back to Steve.

Stephen D. Steinour

Thank you, Dan. Turning to Slide 25. As I mentioned in my opening comments, our Fair Play banking philosophy coupled with our Optimal Customer Relationship or OCR is driving accelerated new customer growth and cross-sell share of wallet. This slide recaps trends in consumer checking account households. For the full year, we grew consumer checking account households by 10.3%. Importantly, 73.5% of our households use over 4 products or services, a significant improvement from 69.4% at the end of last year. For the fourth quarter, related revenue was $231 million, down 4.1% from the prior year and $21 million lower than in Durbin -- lower than the third quarter. The decline in revenue largely reflected the impact of the Durbin Amendment and a reduction in debit card interchange fees. Slides 32 and 33 in the appendix detail these quarterly trends.

We believe what we are developing is a competitive advantage. When rates rise, and they will eventually, we believe we will have a deeply cross-sold and loyal customer base. Our market positioning is resonating strongly with customers and prospects. It's gaining a national following. MONEY Magazine recently named Huntington the best bank in the Midwest.

We're seeing similar trends in our commercial relationships as shown on Slide 26. Commercial relationship growth was also strong. After growing 4.9% in 2010, commercial relationships in 2011 grew at an 8.4% rate, a 71% increase. And at the end of the fourth quarter, 31.4% of our commercial relationships utilized 4 or more products or services, up from 24.2% a year ago, and related revenue is also increasing. Related revenue for the quarter fourth quarter was $175 million, up over 9% from a year ago. Slides 34 and 35 in the appendix provide additional details.

Now Slide 27 is our last slide and recaps our expectations for 2012. With regard to the economic environment, while we have recently seen some encouraging signs, we do not anticipate much change. It remains uncertain and the Federal Reserve's intention to maintain low interest rates through 2013 provides a significant revenue headwind for banks. In addition, consumer and business confidence remains fragile.

With regard to net interest income, we anticipate modest growth from 2011 fourth quarter levels. The momentum we are seeing in total loan growth is expected to continue as growth in low cost deposits, although the benefit from this growth is expected to be mostly offset by net interest margin pressure.

C&I loans are expected to show meaningful growth, reflecting the benefits of our strategic initiatives to expand our business and commercial lending expertise into related verticals like healthcare, asset-based lending and equipment finance in addition to our middle market lending. Commercial real estate loans are expected to continue to decline but at a slowing place as we begin to approach a level that is more in line with our overall aggregate moderate- to low-risk profile.

Residential mortgages and home equity loan growth is expected to remain modest. We continue to expect to see strong automobile loan origination although on balance sheet, growth will be muted due to the expectation of completing occasional securitizations.

Growth in low- and no-cost deposits will remain our focus. Growth in overall total deposits, however, is expected to be slightly less than growth in total loans.

Fee income is expected to show modest growth throughout 2012 from the fourth quarter level now that it fully reflects the debit card interchange impact, the last significant mandated fee reduction of which we are aware. This modest growth we expect will be driven by increased cross-sell success, growth in key activities related to customer growth, as well as an increased contribution from our capital markets activities, treasury management, insurance and brokerage business.

Noninterest expense is expected to increase slightly. While we will continue to focus on extracting further expense efficiencies, that benefit is anticipated to be partially offset by continued strategic investments, such as opening 40-plus new in-store branches this year and the cost associated with consolidating 29 traditional branches along with higher regulatory cost.

From the credit front, nonaccrual loans and net charge-offs are expected to continue to decline.

The level of provision expense, as mentioned earlier, is pretty much in line with our long-term expectations, but there could be some quarterly volatility given the uncertain and uneven nature of the economic recovery.

As we've done for the last 2 years, our focus is on continuing to execute our core strategy. We will make selective investments and initiatives to grow long-term profitability. We will also remain disciplined in our growth and pricing of loans and deposits where we believe there is still some leverage from the existing book. Our Fair Play coupled with OCR is proving to be absolutely the right strategy and market positioning for us. We'll remain focused on improving cross-sell. We believe 2012 will be another year of marked progress in positioning Huntington for better sustained long-term earnings growth and profitability.

So thank you for your interest in Huntington. Operator, we'll now take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Brian Foran with Nomura.

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

I guess as I think about the guidance in the quarter, one of the concerns I hear a lot is you're making $0.14 right now, the guidance implies stable provision, maybe modest preprovision earnings growth. So maybe next year you're in that $0.60 to $0.65 range, but people kind of struggle with where the next leg of earnings growth would come from that base given that the credit story is kind of reaching a steady state, as you put it. So is it capital management that provides that next leg? Or is it just slow and steady preprovision earnings growth? Or are we kind of building a coiled spring here where maybe earnings don't grow very much for a while but you keep building the customer base and someday when rates are higher and the environment is a little bit better, the value of that embedded base you've built really starts to show through?

Donald R. Kimble

That's a long question, Brian. This is Don. I'll go ahead and take a first crack at it. I think you're hitting on one of the long-term things for us. We are building a customer base that we think will be worth much more to us and to our shareholders as the normal rate environment recovers. But more importantly than just the balance sheet aspects of it, it's the ability to cross-sell and deepen that relationship. We've been talking about OCR for a couple of years now, and we are seeing positive trends there. We do believe that, that will allow us to continue to grow our bottom line. We've faced a lot of headwinds last year, with Reg E this year, with Durbin and throughout the time period with this very low rate environment, and we think that we're just continuing to position the company to benefit from that in the long term. Stephen, do you have additional thoughts you like to add there?

Stephen D. Steinour

Yes. Brian, I think the spring analogy in a different rate environment may have some accuracy, but we're trying to provide a steady level of growth and we're conscious of the rate of investment in order to achieve that growth but intend to make what we think are prudent long-term investments as we continue.

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

And just a follow-up on auto securitization environment. Is the gain on sales percentage that you generated last year -- I realize the environment can change, but as you look at the market right now, is that a good base for us to think about in terms of what the gains could be going forward? Or has anything changed in terms of the environment?

Donald R. Kimble

I think that you're right, that it will depend on the market environment. But I'd say that when we did our last securitization transactions, rates had come down dramatically prior to that time period. So that would've influenced the gain a little bit, but it's not going to be markedly different than what we showed on a proportional basis.

Operator

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

Ken A. Zerbe - Morgan Stanley, Research Division

The question I have was just on the margin a little bit. Embedded in your guidance, obviously, is higher NII but it looks like NIM compression. I totally understand, but if there -- can you quantify kind of the level of NIM compression that you're thinking about through 2012? And I guess I'm looking at Slide 11 here, and it looks like the negative aspects of the change in margin added up to about 11 basis points. Aside from what you can get on the deposit repricing side, is 11 basis points on the asset side every quarter a reasonable number?

Donald R. Kimble

Ken, as far as our guidance, we would say that generally, margin is fairly stable or within a fairly narrow range with where we are in the fourth quarter. I'd say the negative items there that you have, as far as the 11 basis points that while we are continuing to see some pressure on loan yield as the loans mature and are replaced, some of the other items that we had there as far as the hit from the investments, the liquidity and even some of the derivative impacts we've experienced over previous quarters are going to continue to be minimized compared to what we're showing here in the fourth quarter trend. And so we continue to believe the deposit rates and mix will continue to help offset those negatives or drag and allow us to maintain a fairly stable margin prospectively.

Ken A. Zerbe - Morgan Stanley, Research Division

All right, that helps. And then maybe just a follow-up to Brian's question. It'll be a little more direct. Is there any reason -- what does it take to get your ROA up from 90 basis points back up to the 130? Does it simply take higher rates or better loan spreads? And if that's the case, is it then just a matter of waiting for rates to rise?

Donald R. Kimble

I don't think we're going to be dependent on just the rate environment. I think it's going to be continuing to show some positive operating leverage given the challenges we've had here as far as Reg E and Durbin and allowing some of that organic revenue growth to exceed the expense growth prospectively, and that will help drive that ROA up.

Operator

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

Leanne Erika Penala - BofA Merrill Lynch, Research Division

My first question is just a clarity on the expense guidance. If I'm backing out the gain on the debt extinguishment, I'm looking at a run rate at about $440 million, but I understand there are some debit card conversion expenses in there of $3.8 million and some branch conversion cost of $3.6 million. What is the run rate upon which we should look at higher expenses for 2012?

Donald R. Kimble

I think there are a lot of puts and takes and you've outlined most of those, Erika. And generally, that would bring it to more at the core level based on what you had talked about. Now there is seasonality in some of the trends. So as we go into the first quarter of next year, you would see the normal employer tax and other seasonal cost to hit us that would drive those expenses up. But as we've said before, from that base that you talked about, we would expect the core expenses to come down, but we will see the impact of investments resulting in a slight increase in expenses prospectively from that core base that you mentioned.

Stephen D. Steinour

And obviously, Don meant this year, not next year.

Donald R. Kimble

Okay. Good.

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Okay. And just a question on credit. We saw an uptick in resi real estate and on home equity late stage delinquencies and also an uptick in overall NPL inflows. Is that to the seasonality that was talked about during prepared remarks? Or is the consumer in your footprint really continuing to struggle and that lends to some of more conservatism in terms of your provision outlook for next year -- this year?

Daniel J. Neumeyer

Yes. So 2 things there, Erika. Obviously, on the commercial inflows, that is not seasonality. That's just kind of the choppiness of the market and as we look back over the last year, there's been some unevenness. But generally, the trends have been in the right direction. So even though inflows are elevated over what we would like to see, we still think they're going in the right direction and will continue to reduce. On the consumer side, when you really look at the trends and cut through all the numbers, it's really the residential that are off in the 90-day category and we've shown you the adjustment on the overall consumer for the securitization effect, and so the overall impact really is not as great as what it would appear. So really, I think we're doing fine in auto. Home equity's flat. But at residential, what we're really seeing is the effects of the market. There are borrower delays, the bankruptcy, filing process and the whole foreclosure timeline has been extended and that has resulted in the higher late stage delinquencies. So part of it is just seasonality, which we do see every year and will expect to see improvement in the first quarter there. But the whole timeline of the residential has been extended and that accounts for a piece of it. Now as I also mentioned, we have -- we write down to net realizable value at 150 days. So there is not additional large exposure in those numbers. And we are very much trying to manage the delinquencies on the front end. We have our collections group very active. We have our home savers group. We've established a single point of contact to make the process more efficient. So we're really tackling it on the front end. So in the big picture, we feel pretty good about where we stand and don't see any trends that are alarming. And I don't think it has anything to do with our geography, in particular, to answer your final question.

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Got it. And just a quick follow-up to that. We appreciate the provision guidance that you gave for 2012, but looking out beyond 2012, what benchmarks should we look at in terms of measuring what an appropriate level of provision should be? Are we looking at coverage relative to charge-offs, coverage relative to NPLs or reserve relative to loans? How should we think about on a long-term level beyond 2012?

Daniel J. Neumeyer

We look at every one of those measurements every quarter. We will see a tightening in the spread between provision and charge-offs as we reached normalized levels. But every quarter, we're just going to do our typical analysis. We look at every portfolio. We look at the economic environment. We do have improving trends but we also, as we'd just talked about, have an increasing flow of NPAs and criticized loans over and above what we would normally see. So I think our coverage ratios will remain strong. But like the ACL to loans ratio, I would expect it to be on a slow ramp downwards for the balance of the year.

Stephen D. Steinour

As you look at future periods, to answer your question, Andrea (sic) [Erika], it's likely to be more influenced by reserves to total loans as the charge-offs in NPA, NPL normalize.

Operator

Your next question comes from the line of Ken Usdin from Jefferies & Company.

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

Just coming back on Erika's question, just making sure we all hear it right. So expense growth this year on a full-year basis should come off of the core number for 4Q?

Donald R. Kimble

That's correct, yes.

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

Okay, okay. In the last quarter, you guys had talked about service charges growing third to fourth. If I remember correctly, they were down a few million in the fourth. I just wanted to ask you for a little color on that. Is there anything that you're changing with regards to pricing? Or is there anything changing with regards to customer behavior? Or was that just a different type of seasonality?

Donald R. Kimble

We saw a little bit less than expected customer activity on the consumer side, driving down charge-offs a little bit from our expectations. And the other thing that continues is that the commercial customer is usually -- is using those higher DDA balances that essentially pay for their transaction fees. So we're seeing pressure on the commercial service charge category as well.

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

Okay. So that's -- is that economic? Or is that just a choice decision?

Donald R. Kimble

I'd say that it's both from their perspective. And in the credit rates that they would have from those higher balances, it's still fairly nominal given the low rate environment, but they just don't have a lot of other options to use with that additional cash. So this is one way for them to manage their portfolio or liquidity position.

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

Okay, I got it. All right. And then Don, I heard your point earlier about how you feel very confident on capital levels going into CCAR. And I just was wondering, I know you're not going to tell us about what you asked for specifically, but can you just remind us again at the corporate level your general preferences in terms of dividends versus buybacks and how you just approach that from a "top of the house" perspective?

Donald R. Kimble

We really haven't provided a whole lot of guidance there. What we have said is that we do believe that the regulators are sticking to their 30% kind of guidance for capital on cash dividend. We have said historically that even with a 30% payout, our capital ratios over time would continue to increase, and so we would have to evaluate other capital management actions. And so our first priority is to make sure that we maintain the appropriate common dividend for our shareholders but really haven't prioritized anything beyond that.

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

Okay. And my final one, just to wrap in all the guidance comments. Steve, I hear your point about not giving pre-pre explicit guidance, although I do think it's probably with the normalized provision, it's still the biggest point to grow from here. But do you have a general view that within the guidance that you've given that you do expect pre-pre to be on a positive track and it's within the kind of outlook? I know you're helping us on a year-over-year basis, but should we see a gradual progression upwards in preprovision from here?

Donald R. Kimble

This is Don. I'll go ahead and answer that. With our guidance, particularly in the guidance for the increased net interest income and the fee income and joining the expense trends that we've provided, it would expect or we would expect to see positive trends as far as pretax preprovision in 2012 compared to '11.

Operator

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

Craig Siegenthaler - Crédit Suisse AG, Research Division

First just on the balance sheet. I'm just wondering, has your view of holding security tier in this low rate environment all have changed for the past few months? Or should we continue to expect this portfolio to be in runoff?

Donald R. Kimble

It hasn't changed a lot. As far as the decline on period end balances that really related to some actions we're taking close to the end of the quarter that what we also did throughout the fourth quarter was to hold in our portfolio some of the 15-year fixed-rate production into our residential real estate portfolio, and that allowed us to essentially shift between those 2 different asset classes. So we do view our investment portfolio as a needed asset for us for both liquidity and for interest rate risk management. And we've continued to maintain the same type of discipline in keeping that duration of portfolio fairly short. It's right at 3 years or 3.1 years at the end of December, and that's more a reflection of the low rates to take it above the 3-year duration.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Got it. And then just a quick one on noninterest expenses. Two of the items, outside data processing and also equipment had a pretty sharp step-up in the fourth quarter. I'm just wondering if you can help us at all in terms of the run rate for the first quarter, should we see it more flat after this big step-up? Or do you expect as your overall guidance for 2012 still a modest strip higher?

Donald R. Kimble

We really haven't provided the individual line level. What we did say, as far as some of the equipment expense related to some of the transition cost that we have in connection with the consolidation of 29 branches, that the movement there prospectively is in line with just the general statement as far as expenses being slightly up, reflecting the continued investments.

Operator

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

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

Just a little different track in the numbers. I think when people talk about M&A in the regional space, they think of you guys being an acquirer, and I know that there is still a big difference in bid and ask prices. You saw banking audit backed out of the market the other day. What -- do you see some people becoming more realistic on pricing on -- for your acquiring other banks? Are you still out there looking?

Stephen D. Steinour

We are -- we remain in a posture where we're looking. There's -- so really no change. However, in terms of the sellers and we haven't -- and we don't expect necessarily anything to change. There doesn't seem to be any incremental regulatory activity or other things that may prompt to change the market here.

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

And then the other question is your overall market. We've heard some of the regions where there's a lot of -- especially the bigger boys coming in and undercutting pricing and stealing market share from some of the smaller players out there. Can you go -- discuss a little bit about the competition relatively speaking for some of these commercial loans?

Donald R. Kimble

As far as the pricing on commercial loans that -- we really don't see a lot of direct competition from the bigger players in our footprint. Our focus is still primarily on the smaller end of the middle market spectrum. And so while there is some price pressure there that we've been able to maintain our pricing discipline that we have had some very good growth here in the fourth quarter for equipment finance, and that has a little bit different pricing characteristics than some of the other asset classes that we're very pleased with the credit and returns on that business we're looking as well. Dan, anything else that you'd add?

Daniel J. Neumeyer

Yes. I think, actually, we're -- of course, there is some pricing pressure but what we're -- I think we're holding our own there and I think what we're trying to be more focused. We have walked away from deals that have gotten too aggressive on the structuring end. And so -- by and large, pricing remains competitive, but we don't feel like we're losing significant business because of being undercut.

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

When you say that structuring end, is that -- do you mean too many covenant light-type deals? I mean, can you elaborate on that?

Daniel J. Neumeyer

Yes, there are -- we have seen some -- just we're not comfortable on some of the multiples that are being allowed on senior debt or total debt. We are seeing some more aggressive structures there and have elected just not to participate in those.

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

Okay. Is that coming from the smaller players or the bigger players?

Daniel J. Neumeyer

This would be driven by the structuring ARMs of the larger players.

Operator

Your next question comes from the line of Chris Mutascio from Stifel, Nicolaus.

Christopher M. Mutascio - Stifel, Nicolaus & Co., Inc., Research Division

I'm going to beat this horse, I guess, fully dead, but I want to -- I'm trying to get a grapple with the provision expense. I realized provision to average loans, you look like you're pretty much at a historical level or more normalized level. But given very strong coverage ratios and your guidance for improved credit quality, which means those coverage ratios probably can only get stronger, I would've thought maybe your provision expense will kind of blow through to the downside, if you will, normalize provision levels for the next several quarters, maybe through 2012 before you get back to normalized levels. So I guess my question is, why now holding off on further or even in more additional reserve releases given the type of credit quality improvement you're seeing and still expecting?

Stephen D. Steinour

We're also growing the commercial book at an annualized rate that's a nice multiple GDP. And so we're just trying to be cautious and prudent and make sure we're strong in -- for the foreseeable future.

Christopher M. Mutascio - Stifel, Nicolaus & Co., Inc., Research Division

So is that another way of saying that you're going to -- that you can grow into the reserve to loan ratio over time because of the strong loan growth?

Daniel J. Neumeyer

I think that's an aspect of it. And obviously, we're keeping our eyes on the -- as we talked about, the NPA inflows and criticized. That is kind of a counterbalance. It makes us just remain cautious on that end. So we're trying to strike the right balance, and we do feel that portfolio is going to continue to improve in quality, but we've got our eye on some of the other metrics as well.

Operator

Your next question comes from the line of Steve Scinicariello from UBS.

Stephen Scinicariello - UBS Investment Bank, Research Division

I just want to follow up with you, just given the strong C&I growth, 6% sequentially, just looking to get a little more color on some of the borrower profiles there. We know the overall pie isn't growing in terms of the economy. So I'm just kind of wondering where your market share is coming from and what it looks like.

Daniel J. Neumeyer

Well, we're encouraged by the fact that it's broad based. So we are seeing growth in our various geographic markets in the traditional middle market. As we mentioned earlier, we're also seeing strong growth in equipment finance and in the large corporate segment. And the one thing about the large corporate segment is that in 2011, of those new larger relationships that we added, 88% were cross sold. That's a big number for us. It's important. 75% of those loans were in our core 6 to 8 footprint. So we like where the growth is coming from. We think it's on strategy and it aligns very well with our OCR cross-sell initiatives.

Stephen Scinicariello - UBS Investment Bank, Research Division

Good. It's good. It's helpful. And then switching gears over onto the margin side of the equation. I noticed the benefit from shifting the deposit mix and growing those core deposits helped by about 15 bps in the quarter. I'm just kind of wondering what other levers you have to pull there with deposit costs down near 61 basis points or whatever. Do you have much more to go on the deposit repricing side or a mix shift in terms of benefit?

Donald R. Kimble

We still believe there is additional opportunity there for us to continue to drive down that cost. But even with that improvement in linked quarter, we're still higher than our peers as far as our average cost of funds or our deposit base. We believe with our focus on our transaction balances that, that will continue to drive improvement in the mix and will continue throughout next year. And we still have some CD maturities that are well above rates as well. But over the next 3 quarters, we've got roughly $4 billion of CD maturities at an average cost of north of 170 basis points. So as those come through, we should have some opportunities for us to continue to enhance that margin benefit.

Stephen Scinicariello - UBS Investment Bank, Research Division

And that $600 million of previously collateralized short-term borrowings to direct deposits -- or the demand deposits, what's kind of the flow trajectory of those kind of balances?

Donald R. Kimble

Generally, given that they are short term, they would -- we would expect to see some of those start to roll off over the next several quarters and haven't provided a whole lot of guidance beyond that.

Stephen D. Steinour

Just so you pick it up, it was at $600 million in the previous quarter, we identified another little plug of that.

Donald R. Kimble

$300 million plus or so.

Stephen Scinicariello - UBS Investment Bank, Research Division

Okay, okay. So is that something that we should expect to maybe ebb and flow a little bit? Or is it just kind of a one-off type thing?

Donald R. Kimble

We would expect that to decrease over the next several quarters. So they will create some challenges from quarter-to-quarter as far as the growth rates because of that impact.

Stephen Scinicariello - UBS Investment Bank, Research Division

Got you, got you. And just lastly, just on the -- I know the targeted efficiency ratio is kind of that mid-50s kind of range. Given all that we know, we talked about with regard to expenses and whatnot, how do you get there from kind of the mid-60s range and what's the timing on that?

Donald R. Kimble

We get there by having positive operating leverage going forward. We need to focus on making sure that we're getting the returns on the investments we've already made and allowing those revenues to grow at a faster pace than the expenses. But just this past quarter alone, the impact from Durbin to our efficiency ratio cost us about 140 basis points. So it's a big drag for us this past quarter. And so we just need to make sure that, that will allow us to continue to show the progress toward that mid-50s goal. But you're not going to see it in 2012 results, but we do want to show positive trends in that direction.

Operator

Your next question comes from the line of Jon Arfstrom from RBC Capital.

Jon G. Arfstrom - RBC Capital Markets, LLC, Research Division

A question for you on the consumer cross-sell. Obviously, I'm assuming checking and savings would probably be Products 1 and 2, but where are you moving the needle on that in terms of maybe Products 3, 4 and 5 and where the opportunity is to take that higher?

Stephen D. Steinour

We're much -- we're very focused on moving that into a different digit other than a 4 and we expect to do that in the foreseeable future. So primary products, when you buy a checking account with us, you are typically going to get a debit card. We didn't mention this earlier, but we completed our debit card conversion to MasterCard. We ended up with more cards active, higher utilization, and so that is a partial offset. But as we're growing households at a 10-ish percentage level, virtually all of them are coming with an activated debit. In addition, we try and provide some kind of savings products, savings account, money market account, sweep the balance of their liquidity. And there's a meaningful percentage that also have some form of lending opportunity for us, home equity, mortgage, something that roughly balances part of the asset liability equation a bit. In addition to that, there is an emphasis on our part to do much more with mobile and electronic channels. And our 24-Hour Grace feature of our checking account, for example, provides mobile or text alert. So there's a propensity for consumers to opt into that, and then that sets up different economics as we then distribute statements in other alerts to customers prospectively.

Jon G. Arfstrom - RBC Capital Markets, LLC, Research Division

That's helpful. And then just one question on commercial real estate. It's been obviously a bit of a drag to overall loan growth, but I'm curious if you have any thoughts as to when that category might trough and what kind of opportunities you're seeing in commercial real estate?

Stephen D. Steinour

We would expect it to trough in '12 and -- we have a large core group of relationships that as they become more active or we open the spigot to allow further credit extensions, it will certainly -- will help with the amortization and other prepayment. And frankly, that's the profitable side of the equation where we're looking to build it back as we deplete the noncore side of the real estate. We are looking at becoming a bit more active in the REIT space as well. So it's principally the core customers, maybe a little supplementation with some REIT activity. That would be publicly-traded REIT.

Operator

Your last question comes from the line of Scott Siefers with Sandler O'Neill.

R. Scott Siefers - Sandler O'Neill + Partners, L.P., Research Division

I wanted to -- the first question was just back on the expense line and just, I guess, given how much of the profitability improvement would rely on something like higher rates, for example, to really let the value of the deposit base to go through. I mean, is there a point where just since that still could be years away, is there a point where there would be more of a focus on just dialing down the absolute level of the expense base to help to kind of bridge the gap between now and when rates do rise?

Donald R. Kimble

Scott, we continue to focus on areas where we can get additional efficiencies and that is a key area for all of our management team to make sure that we're driving going forward, but we also believe that we are going to be receiving benefits from the investments we're making. One example that continues onto 2012 is our in-store rollout with Giant Eagle. We've opened over 30 branches here in 2011, and we're to open a similar level plus in 2012. And so those investments do add to our expense base. And we've noted their longer-term focus and their investment returns for us, but we do believe that it positions the company more appropriate for future success. And so where appropriate, we'll continue to make those investments but at the same time, we're going to make sure that we're dialing down on other areas as far as the total expenses to be able to fund those types of other incremental investments for growth.

R. Scott Siefers - Sandler O'Neill + Partners, L.P., Research Division

Okay. And then the last question I have for you, Don, was on the auto loan securitizations. I was wondering if you could just talk conceptually about the other kind of things you think about. I mean, I know about the portfolio limits, but as you think about securitization, so if you -- when you do one, you get the upfront revenue gain, right, but then presumably, there's also a margin cost later on. So what are -- as you do kind of the NPV in a way, kind of keeping, I mean, portfolio versus doing a securitization, what are the things you're weighing at this point?

Donald R. Kimble

Sure. In addition to the upfront game, we do have the annual servicing income associated with that portfolio as well. But the other thing to keep in mind, too, is that as we sold our first securitization structure, we sold the residual interest, and that represents about 3% of the total balances. The implied return on that 3% was right around 12%. So compare that with the roughly 9% capital that we're going to be able -- require to maintain on our balance sheet to support those assets if we keep them on the balance sheet and the kind of returns our shareholders are going to want to see, and so we think that there is a capital efficiency to this structure and program as well.

Stephen D. Steinour

So we're grateful for your interest. We -- there are elements of opportunity that you've questioned us about. As we look back on 2011, a 10.1% ROA, an ROTE of 12.7%, substantial growth, record levels for us in households, in businesses, significant increased penetration on 4-plus products, growth in capital markets and some of the other key business lines for us, we feel we've made progress. We'll be working hard to continue that in 2012. Thanks for your interest.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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