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Executives

Todd Beekman - Director of Investor Relations

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

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

Mary W. Navarro - Senior Executive Vice President, Retail & Business Banking Director, Regional Banking Group President and Senior Executive Vice President of The Huntington National Bank

Stephen D. Steinour - Chairman, 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

Analysts

Leanne Erika Penala - BofA Merrill Lynch, Research Division

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

Matthew D. O'Connor - Deutsche Bank AG, Research Division

Craig Siegenthaler - Crédit Suisse AG, Research Division

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

Ken A. Zerbe - Morgan Stanley, Research Division

Kevin J. St. Pierre - Sanford C. Bernstein & Co., LLC., Research Division

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

Huntington Bancshares Incorporated (HBAN) Q1 2012 Earnings Call April 18, 2012 10:00 AM ET

Operator

Good morning. My name is Matthew, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Huntington Bank First Quarter Earnings Conference Call. [Operator Instructions] Todd Beekman, you may begin your conference.

Todd Beekman

Thank you, Matthew, and welcome. I'm Todd Beekman, the Director of Investor Relations for Huntington. Copies of the slides that we will be reviewing will be found on our website at www.huntington.com. This call is being recorded and will be available as -- for rebroadcast starting about an hour after the call. Please call the Investor Relations department at (614) 480-5676 for more information on how to access this recording playback if you -- should you have difficulties.

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

Turning to Slide 3. Today's discussion includes a Q&A period that may contain forward-looking statements. Such statements are based on information and assumption available at this time and are subject to change, risk and uncertainty, which may cause actual results to differ materially. We assume no obligation to update such statements. For a complete discussion of risks and uncertainties, refer to the slide and material found with the SEC, including our most recent 10-K, 10-Q and 8-K filings.

Now turning to today's presentation. As noted on Slide 4, participating today will be Steve Steinour, Chairman, President and CEO; Don Kimble, our CFO; Dan Neumeyer, Chief Credit Officer; Mary Navarro, Head of Retail and Business Banking Director. Let's get started. Turning to Slide 5. Don?

Donald R. Kimble

Thanks Todd, and welcome, everyone. We're going to mix up the order a little bit today and I'll begin with a review of our first quarter performance highlights, and Dan will provide a review of credit. Mary will continue with an update on our in-store partnership with Giant Eagle. Steve will then provide you with an update of our OCR strategy, review of our Fidelity Bank acquisition and close with a discussion of our expectations for this year.

Turning to Slide 6. We reported net income of $153.3 million or $0.17 per share. That's up 21% from a year ago and also from the fourth quarter. There were 2 significant items that impacted this quarter's results. First was an $11.4 million gain relating to our recently announced FDIC-assisted purchase of Fidelity Bank in Dearborn, Michigan. The other was a $23.5 million addition to our litigation reserves related to previously existing actions taken against us.

Total revenues increased $58.6 million or 9% over the fourth quarter. Our non-interest income growth drove most of this improvement, up $56 million, reflecting the benefit of a $23 million gain from our first quarter auto securitization, the $11.4 million gain from our Fidelity Bank acquisition, and a $22.3 million increase in mortgage banking revenues.

Fully taxable equivalent net interest income increased $2.6 million or 1%. For the quarter, our net interest margin increased by 2 basis points as we continue to lower our deposit and other funding cost. We also had a 5% annualized growth in average earning assets. This growth reflected the benefit of continued strong commercial loan growth, up 17% annualized from the fourth quarter. The auto securitization negatively impacted auto loan growth for the quarter, as we transferred the balances to loans held for sale at the end of last year.

Average total core deposits were stable this quarter with the mix continuing its shift to lower-cost demand deposits. Total demand deposits increased $0.6 billion or 16% annualized. Non-interest expense increased $32.4 million as the quarter included the $23.5 million increase to our litigation reserves. Also, the prior quarter included a $9.7 million gain on the extinguishment of debt related to our TruPS exchange. Adjusted for these items, expenses were essentially flat.

Turning to Slide 7. Our OCR methodology is continuing to drive success throughout the company. On the consumer side, we grew checking account households by an annualized 14.2% this past quarter. This represented an 11.7% growth rate since the first quarter of 2011. More importantly, our cross-sell performance also continued to improve.

At the end of the quarter, 75.1% of our consumer checking account households have over 4 products or services. This compares with 70.5% a year ago, an almost 5 percentage-point improvement. We continue to drive similar success on the commercial side. Annualized growth in commercial relationships was 13.3% this quarter. Our cross-sell measures were also impressive. At the end of the quarter, 32.7% of our commercial relationships used 4 -- over 4 products and services, up from 25.4% a year ago or up over 7 percentage points. These cross-sell metrics continue to reinforce the message that our strategy of acquiring customers and deepening the relationships with those customers through additional sales of financial services is working.

Turning to credit quality. Our metrics continued to improve as well. Non-accrual loans were up 14%. This reduction is after reflecting an $8.7 million addition to our home equity non-accrual loans resulting from the application of the new regulatory standards to our portfolio. Our allowance for credit losses as a percentage of non-accrual loans increased to 206%, which we believe will continue to compare favorably to our peers. Net charge-offs declined 1% on an annualized basis point of -- 85 basis points remained consistent with last quarter.

Our capital position remains strong. Our tangible common equity ratio rose 3 basis points to 8.33%. Our regulatory capital ratio strengthened further with most improving by 10 to 15 basis points from the prior quarter. These ratios reflect the impact of the Fidelity Bank acquisition, which closed on March 30, but they do not reflect any of the capital actions included in our first quarter capital plan.

Turning to Slide 8. Other highlights for the quarter included $400 million purchase of an equipment finance portfolio, which closed in March, allowing us to leverage our equipment finance team expertise. We continue to reposition our branch network, completing a consolidation of 29 of our full service branches in March, providing some efficiency improvements to help fund our investments and strategic initiatives, including our in-store expansion where we added 14 new locations in the first quarter. We also were, again, recognized for outstanding customer service with the APECS 2011 Top Advocacy Award for Customer Service in our region. Huntington had the highest net-advocacy rating for customer service for 3 years in a row.

Slide 9 provides the summary of our quarterly earnings trends. Many of the performance metrics will be discussed later in the presentation.

Turning to Slide 10. We show the summary of -- a summary income statement. We've also adjusted the revenues and expenses for the impact of significant items. On this adjusted basis, revenues were up 8% over the prior year with expenses up 6%. This 2% positive operating leverage is critical for our long-term success and reflects our early-stage results for many of the strategic initiatives we have started over the last several years.

Slide 11 depicts the trends in our net interest income and margin. During the first quarter, our fully taxable equivalent net interest income increased by $2.6 million, reflecting the benefit of a $0.6 billion increase to our average earning assets and a 2 basis-point increase to our net interest margin to 3.40%. The increase in net interest margin reflected the impact of the following: 7 basis-point increase related to the reduction in deposit rates and the improvement in the deposit mix, and this was offset by a 4 basis-point reduction related to the impact of the extended low-rate environment on loan yields.

Slide 12 shows the trends on our loan and lease portfolio. Average total loans and leases decreased $0.4 billion or 1%, which is 4% annualized from the fourth quarter and primarily reflected a $1.1 billion or 19% decline in average automobile loans. Decline from the fourth quarter average balances reflected the December 31 reclassification of a $1.3 billion of auto loans that held for sale.

Originations remained strong in the quarter, with over $950 million of loans booked this past quarter. This decline in average automobile loans was partially offset by a $0.6 billion or 4%, which is 17% annualized growth in average commercial and 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. Very little benefit was recognized from either the Fidelity Bank acquisition or the equipment finance portfolio purchase due to timing in the current quarter.

Continuing onto Slide 13. We've shown continued improvement in our deposit mix over the last 5 quarters as we've increased the non-interest bearing DDA balances from -- to 26% from 18% of total average deposits. The improved deposit mix reflects the success of a fair banking -- Fair Play banking on growing consumer DDA and our treasury management OCR focus on growing commercial demand deposits.

Turning to Slide 14. We show a stable level of total average core deposits. This reflected a $0.6 billion increase in total demand deposits offset by declines in money market deposits of $0.5 billion and core CDs of $0.3 billion. The demand deposit growth reflected strong growth in consumer households, which again increased an annualized 14% pace, and similar growth in our commercial relationships of an annualized 13%. As mentioned last quarter, about $1 billion of our commercial balances reflect temporary deposits, which are expected to decline over the next couple of quarters.

Slide 15 shows the trends in our non-interest income, which increased $56 million or 24% from the prior quarter. The increase reflected the $23.9 million of higher gains on loan sales as the current quarter included $23 million of gain associated with our automobile loan securitization. We expect to have about 2 securitizations a year going forward. This quarter also showed a $22.3 million increase in mortgage banking income driven by a $10 million increase in origination and secondary marketing income, as well as a net improvement of about $12 million in our MSR hedging activity, as the current quarter included a gain of $7.7 million compared with a $4 million MSR loss last quarter. Other income included an $11.4 million gain related to the Fidelity Bank acquisition. This was offset by a $7.2 million decline in mezzanine investment gains.

The next slide summarizes expense trends. Non-interest expense increased $32.4 million or 8%. Again, this included the impact of the $23.5 million increase in our litigation reserves, previously existing actions recorded in the other non-interest expense. In addition, it reflects the prior quarter's benefits of the $9.7 million gain on the early extinguishment of debt related to our trust preferred securities. Other areas to note include a $15.4 million increase in personnel costs, as this quarter reflected a $9 million increase in benefit expense, primarily seasonal payroll tax-related, and a $6 million increase in performance-based incentives. It also reflected an $11.4 million reduction outside data processing and other services. This is primarily due to the prior quarter costs associated with the conversion to a new debit card processor.

Slide 17 reflects the trends in our capital position. These are all as of end-of-period balances and reflect the addition of over $700 million of assets from the Fidelity Bank acquisition. Tangible common equity ratio increased to 8.33%, up from 8.3% the prior quarter. The Tier 1 common risk-based capital ratio increased to 10.15%, up from 10% the previous quarter. We believe this increase is noteworthy during a quarter when we grew risk-weighted assets by nearly $1 billion. With that, let me turn the presentation over to Dan Neumeyer to review the credit trends. Dan?

Daniel J. Neumeyer

Thanks, Don. Slide 18 provides an overview of our credit quality trends. The first quarter continued to show good overall improvement in our credit quality metrics. Net charge-offs fell by $1 million, and net charge-off ratio remained flat at 85 basis points reflecting slightly lower average loans, particularly due to the March automobile securitization. We do expect the positive trend in charge-offs for the balance of the year, although the pace of improvement will likely remain more modest as we move closer to normalized charge-off levels.

Loans, 90-plus days delinquent and accruing were down in the quarter, falling to 15 basis points. This is an improvement from the prior quarter and also an improvement over the prior year. We continue to have no commercial delinquencies in the 90-day plus category. The non-accrual loan ratio fell noticeably to 1.15% from 1.39%. This was the largest quarterly reduction in the non-accrual loan ratio in over a year. The Criticized asset ratio also showed a meaningful reduction in the quarter falling to 5.8% from 6.53%. The allowance for loan loss, loan and lease lost, and the ACL-to-loans ratios fell to 2.24% and 2.37% from 2.48% and 2.60%, respectively, due to the asset quality improvement. However, the ACL to NAL ratio increased from 187% in the prior quarter to 206%, even with the addition of $8.7 million of performing secondly in home equity loans that are sitting behind delinquent first mortgage as we implemented the new regulatory guidance that was issued earlier this quarter.

Slide 19 shows the trends in our non-accrual loans. The charts on the left demonstrate the continued reduction in the level and percentage of our non-accrual loans. The 14% reduction in the first quarter was the largest percentage reduction experienced in the last year. As shown on the charts on the right, during the quarter, we also experienced the lowest level of new inflows that we have seen in several years.

The performance of the commercial book was very strong. We did see a modest increase in consumer non-accruals, due in large part to the addition of $8.7 million of the home equity non-accrual loans due to the new regulatory guidance just mentioned. As we reach a more normalized level of nonperformers, the change between quarters may have some level of variability, although we expect the overall trend to remain positive.

Slide 20 provides a reconciliation of our non-performing asset flows. NPAs fell by 11% in the quarter, compared to a 4% reduction in the prior quarter. Inflows were down 29% from the prior quarter and was the primary driver of the overall decline.

Turning to Slide 21. We provide a similar flow analysis of commercial Criticized loans. Inflow of new Criticized loans was 28% lower in the first quarter compared to the fourth, and was the primary contributor to the 8% reduction in Criticized loans for the quarter. Upgrades to Pass were steady for the quarter, while paydowns were somewhat lower.

Moving to Slide 22. Commercial loan delinquencies were up modestly from the prior quarter, although they remain very well controlled and within expectations for current and future periods. We continue to have no 90-day plus commercial delinquencies, and as a result of our early identification and treatment of problem loans.

Slide 23 outlines consumer loan delinquencies, which were down modestly in the quarter in both the 30- and 90-day categories. This is consistent with typical seasonal patterns. Year-over-year performance was flat in the 30-day category and showed modest declines in the 90-day segment. The black line on the left side of the slide excludes government guaranteed loans and shows an improvement in the 30-plus day category to 1.87% from 2.06% in the prior quarter. Auto and home equity both showed improvement in the quarter, while residential delinquencies were up slightly.

On the right, the 90-day plus delinquencies fell to 32 basis points from 40 basis points in the prior quarter. In the 90-day category, all consumer segments saw improvement in the quarter.

Reviewing Slide 24. The loan loss provision of 34.4 was lower than the prior quarter and was less than charge-offs by $48.6 million. The ratio of ACL to NALs improved to 206%. The ACL to loans declined to 2.37% compared to 2.6% last quarter, although we believe this is to be a very solid ratio, given the continued improvement in the risk profile of the portfolio.

Overall, despite the continued challenges presented by the economic environment, we remain pleased with the direction of credit quality across the portfolio and expect continued improvement throughout 2012. Let me now turn the presentation over to Mary Navarro to provide an update on our in-store channels. Mary?

Mary W. Navarro

Thank you, Dan. Turning to Slide 25. Now that we're 18 months into our partnership with Giant Eagle, we wanted to provide you an update on the progress we've made and the great results we're seeing. We signed a 15-year agreement with Giant Eagle, one of the largest grocers in Ohio. Giant Eagle has significant market share in most of the state. We wanted to have full service branches in grocery stores because convenience is very important to customers, both consumers and small businesses.

As you can see from Slide 25, adding 104 in-store branches significantly improved our branch market share in many markets. In fact, when we complete 2012, we'll have more branches in Ohio than any other bank. Again, making it more convenient for our customers. When the buildout is complete, we'll have almost 500 branches across the state with a population of nearly 12 million.

Turning to Slide 26. The grocery store branch is a very efficient point of distribution. The average Giant Eagle store has 5x to 6x more customer visits per week than a traditional branch. Most customers are usually there more than 2x per week. When you look at Giant Eagle's customer demographics, they're very attractive. The income, network, homeownership and college degree percentages are all higher than our overall customer base and a stand-out when compared with Ohio -- the Ohio average.

Giant Eagle's customer base is a great fit for us, and we're acquiring them at a fast clip. 10% of our new customer households have come from our 40 Giant Eagle branches, which is less than 6% of our total branch count. This is happening because our colleagues are out in the grocery store aisles helping customers find what they need in the store. They're also using an iPad to download coupons to the customers of Giant Eagle's foodperks! account, so that when they check out, they actually get the advantage of those coupons right there that day. They also can be seen occasionally bagging groceries. They're really looked at as the friendly banker. The transactions have also ramped up in these branches and faster than a new -- traditional branch, proving out the fact that customers appreciate the added convenience.

The cost to build an in-store branch is 1/8 of a traditional branch. Plus, there is less ongoing overhead. We have 3 branches that have been open 18 months, and they're all very close to breaking even and are on track to meet our 24-month goal. As customers continue to use more and different technologies to do their banking, fewer customers will use the branches for transactions. We think the full-service bank branch inside a grocery store will be a convenient alternative for new product purchases like mortgage, investments or insurance. We're doing this very differently than other banks. We have a different type of colleague. They're all universal bankers that do more than just take deposits. We have also full-service branches, and the bankers working there are gold like the colleagues at a traditional bank. The focus is on acquiring new customers and building deep relationships. We're also open more hours, 7 days a week, totaling 75 hours.

We're very excited about the results so far and are thrilled to have Giant Eagle as our in-store partner, not only because they have a great customer base but because we're able to work together to come up with new ways to grow both of our customer bases. Now, let me turn it back to Steve.

Stephen D. Steinour

Thank you, Mary. Turning to Slide 27. As mentioned in Don's opening comments, our Fair Play banking philosophy, coupled with our Optimal Customer Relationship, we call it OCR, it's clearly driving accelerated new customer growth and product penetration. This slide recaps the continued strong upward trend in consumer checking account households. In the first quarter, consumer checking account household growth accelerated 14.2% and has grown by 11.7% from a year ago. Importantly, 75% of total households use over 4 products or services, a significant improvement from 73.5% at the end of last year.

For the first quarter, related revenue was $237 million, up 2.6% from the fourth quarter of 2011. However, it was $12 million lower than a year ago, due mainly to the impact of the Durbin Amendment's mandated reduction of debit card interchange fees. While notably, related revenue was up $8 million since the first quarter of 2010, which is pre-Reg E and pre-Durbin. We continue to analyze potential opportunities to expand the product offering, and most recently began developing our own credit card product, which we plan to roll out in 2013.

Slides 36 and 37 in the appendix provide additional details of consumer quarterly OCR trends. We're seeing similar trends in our commercial relationships as shown on Slide 28. Commercial relationship growth was also strong and also accelerating. After growing just over 8% in 2011, commercial relationships in the first quarter grew at an annualized rate of 13.3% and are up nearly 10% from a year ago.

At the end of fourth quarter, 32.7% of our commercial relationships utilized 4 or more products or services, up from 25.4% a year ago. Related revenue, while experiencing its usual seasonal first quarter decline, increased $12 million or 8% at this time last year, and by over $30 million since the first quarter of 2010.

Slides 38 and 39 in the appendix provide additional details. On Slide 29, as we announced on March 30, we acquired Fidelity Bank in Dearborn, Michigan through an FDIC-assisted transaction. As we've told you for several years, we're looking for acquisition targets. They're between $500 million and $2.5 billion in size in our footprint, which are financially attractive. Fidelity definitely fits these criteria. We acquired approximately $800 million in assets and assumed a similar amount in liabilities.

After performing due diligence on more than half the loan portfolio, we bid $150 million asset discount that eventually led to the $11.4 million bargain purchase gain that Don described earlier. This is a strong franchise with 15 branches that are north and west of Detroit and stretch to Ann Arbor. We have some overlap and plan on consolidating 6 branches out in the combined network.

Importantly, the acquisition is a nice, little tuck-in deal that will add more than 18,000 Fidelity customers to our platform, where we can provide a broader range of products, and some of the highest-rated customer service in the industry. This acquisition, coupled with the recent CapPR result, provides a good opportunity for us to review our longer-term capital priorities. Those priorities coincidentally align with the timeline of the last 2 years.

After ensuring appropriate capital and risk levels, rallying the core business is our top priority. Over the last 2 years, Huntington has invested in people, products and services required to become a top quartile-performing bank. We analyze those investments monthly to our goals, and are nimble enough to be able to quickly reallocate resources. We can clearly see the benefits of those investments to the growth of our customer relationships. Since the first quarter 2010, we've added nearly 200,000 consumer checking households and over 20,000 commercial relationships. Much of the groundwork of those investments is behind us. But there are still some pieces, like the completion of the Giant Eagle in-store buildout, to be completed.

Our next capital priority is dividend. During the middle of last year, the board raised the dividend from $0.01 per share per quarter to $0.04, and we announced the target payout range of 20% to 30% of net income available to common shareholders. We will continue to evaluate the dividend and have a view that the regulators, with their comments on increased scrutiny, have placed a cap on the dividend payout ratios of most banks at around 30%.

As we announced in mid-March, the Federal Reserve had no objection to our proposed capital actions, which included the potential repurchase of up to $182 million of common stock. As a result, the Board of Directors authorized a share repurchase program consistent with that capital plan. Like the other aspects of our approach to capital management, we will be disciplined in this activity and see a direct relationship between the price of our stock and the number of shares we may repurchase during any given quarter.

The next capital priority is to use it for other strategic actions and we're defining strategic actions very broadly, and that would include possibly acquisitions, portfolio purchases or remixing our liabilities. Disciplined management of capital to improve long-term shareholder risk-adjusted returns is of paramount importance. Hopefully you all can see the clear progression we've made over the last several years, and know that Huntington's management with their requirements to hold 50% of their net stock awards to retirement is standing right alongside us long-term shareholders.

Turning to Slide 30. Over the course of the last 6 months, investors have been asking about our view that the Midwest is recovering faster than the rest of the country. We believe that there's strong evidence the Midwest is turning from the rust belt, historically, to a recovery belt, with that being led by a growth in manufacturing, education, medical and natural resource investments. According to the March Philadelphia Fed Coincident, in economic activity index, our footprint states are predicted to grow faster than the country as a whole, and the recovery in unemployment is leading the nation in some states.

For example, in February, Ohio's unemployment rate dropped to 7.6%, Pennsylvania to the same number, Indiana to 8.4. Michigan is now back to levels not seen since 2008, at under 9%.

Manufacturing generally is strong or at least returning. For example, auto companies are predicted to increase production over 14 million units in 2012, up from 10 million units just a few years ago. Several major manufacturers have opened or expanded new plants, investing hundreds of millions of dollars in Midwest-based facilities.

The natural resources boom from the Utica and Marcellus Shale covers half the states in our footprint, and the multiplier effect of the E&P exploration and production investment is clearly evident. It's in the commercial real estate and the growth in jobs relating to steel, construction and broader chemical industrial complexes.

With the investments we have been making since 2009, our OCR sales process and focus, we are clearly capitalizing the benefits of this recovery as evidenced by improving credit quality, growth in SBA loans and 8 consecutive quarters with commercial loan growth. Midwest is an exciting place to be and Huntington is right in the middle in capturing the disproportionate benefit from this recovery.

Slide 31 is our last slide and recaps our expectations for 2012. With regard to the economic environment, some of the encouraging signs seen late last year continue to build throughout the quarter. While our footprint states are clearly benefiting from this recovery, the U.S. and global economies continue to experience elevated levels of volatility and uncertainty. This requires that we remain cautious.

With regard to net interest income, we anticipate modest growth. The momentum we are seeing in total loan growth, excluding any future impacts of additional auto securitizations, is expected to continue, as is growth in low cost deposits. Although 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 through related verticals like health care, asset-based lending and equipment finance. Commercial real estate loans are expected to decline from current levels but at a slowing pace, than that which we have seen over the last several years as we begin to approach a level that is more in line with our overall aggregate, moderate-to-low risk profile and concentration limits.

Residential mortgages and home equity loan growth is expected to remain modest. We continue to expect to see strong automobile loan originations. About one balance sheet growth will be muted due to the expectation of completing the occasional securitizations. Growth in low- and no-cost deposits remains 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 from the first quarter level, and we excluded the bargain purchase gain, auto securitization and any net impact from the MSR. This modest growth, we expect, will be driven by increased cost cross-sell success, growth in key activities related to customer growth, as well as increased contribution from our capital markets activities, treasury management and brokerage business.

For the full year, we anticipate positive operating leverage and modest improvement in our expense efficiency ratio. This will likely reflect the benefit of revenue growth as expenses could increase slightly. While we continue -- we'll continue our focus on improving expense efficiencies throughout the company, additional regulatory costs and expenses associated with strategic actions, including the planned opening of over 40 in-store branches, along with the integration of Fidelity Bank, may offset any efficiency improvements.

On the credit front, we expect to see a continued improvement. The level of provision expense, as mentioned earlier, is at the low end of our long-term expectations. And there could be some quarterly volatility, given the uncertainty and uneven nature of the economic recovery. As we have done over for the last 2 years, our focus is on continuing to execute our core strategy, to make selective investments and initiatives to grow long-term profitability. We will remain disciplined in our growth and pricing of loans and deposits. There is still some leverage there. Our Fair Play banking, coupled with OCR, is proving to be absolutely the right strategy and market positioning for us. We will 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. Thank you for your interests. Operator, we will now take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first 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 relates to 2 loan categories that everybody in the industry has talked about as very competitive, commercial C&I and auto, where your yields were respectively flat to up 7 basis points. Could you give us a little bit more color on how -- the reasons why the yields held in -- held so much this quarter, and relative to your margin guidance, what your expectations are for a future potential pressure?

Donald R. Kimble

Good question, Erika. This is Don. I'll take the first crack and at the end of the comment, additionally on the commercial. But as far as the auto, the reason for the increase in their link quarter really reflects the impact of taking some of the more recent production originations and transferring them into held for sale or at the end of the fourth quarter. And so those were a lower-yielding loan compared to the portfolio in the aggregate. Now that being said, we were very pleased with our production in the current quarters, that originations, as I said, were in excess of $950 million. Spreads were still in that 2 to 2.25 spread and adjusted range that we had targeted before, and they were actually up slightly from the previous quarter. And so we've been pleased with our ability to continue to maintain the appropriate yields on that portfolio and have a good success in originating volumes with those levels. On the commercial loan side, you're right, that the market is very competitive, especially if you look at the upper middle market and large corporate books. We are seeing more pressure downstream as well, that our guidance prospectively says that our margin should be relatively stable, having some slight pressure because of lower interest rates, but it's also given the expectation that we are going to continue to see some pressure on commercial loan yields. Dan, any other thoughts on that?

Daniel J. Neumeyer

No. I mean, I concur with those comments. We are -- obviously, it is -- C&I side is quite competitive. I think everybody's feeling that pressure. I think we've worked hard to maintain those margins. We'll continue to see some pressure going forward, but we're pretty pleased with what we're able to maintain at the present time.

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Okay, and the second question, before I move back into the queue. Your guidance on the expense side for modest growth, does that exclude the litigation -- the addition to the litigation reserve that you booked this quarter? And that, are the actual run rate that we should be growing from would be closer to $439 million on a quarterly basis?

Donald R. Kimble

You're absolutely right, Erika, and it would reflect impact of the Fidelity acquisition and other initiatives that we have. That's correct.

Operator

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

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

I guess, a follow-up on the auto. The cumulative loss expectations, back in the appendix, are going up. Is there -- I guess, what's driving the higher cumulative loss expectations, fully recognizing that they're still at pretty low levels?

Donald R. Kimble

We would consider those very low levels. I think for the past quarter, they're up a little bit because of the mix of used versus new. And as I mentioned, we were actually seeing a slight increase in the credit adjusted spreads during the past quarter, and that's reflective of a little bit higher loss expectation. But we haven't changed our underwriting standards. Again, very pleased with the overall credit outlook. And so, that's more of an indication of why we're seeing higher loss rate. You'll see a slight tick down in average FICO scores there, too, but not meaningful.

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

And then just kind of, as we think about overall level of gain on sale that we should kind of expect over time, the $23 million versus the $1.3 billion of securitizations, do you have any historical context? I mean, is that kind of 1.7%, 1.8% gain on sale rate? I recognize in the short term, it will fluctuate based on auto rates and to your swap spreads, but is that a normal level of gain on sale, or are we historically high right now? Or where would you peg it?

Donald R. Kimble

That's a good question. I wish we had a crystal ball to more accurately predict that, but that our third quarter securitization last year was at a 1.5% gain. Now, we're at $50 million a gain on a $1 billion securitization. This quarter was helped because it was a publicly registered transaction as opposed to a private transaction in the third quarter of last year. So we hope that with our continued familiarity in the market as far as our asset quality and the performance for underlying indirect auto loans in those securitizations, we'll be able to maintain appropriate spreads and pricing, but I don't want to put guarantees out there as far as any market condition changes. But that's a reasonable expectation based on what we're seeing right now.

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

And the last one I had was just competitive environment in Ohio. Some of your competitors, I guess, have highlighted it as particularly bad on the commercial lending side. How would you kind of see the competitive environment in Ohio?

Stephen D. Steinour

I don't know that I would consider it any more competitive than -- we're only in the Midwest, so I think we generally feel like the competitive environment is fairly consistent across that footprint, and I think now, folks are realizing that with the recovery, it's a good place to be. So I would expect that will continue, but I wouldn't say that we feel it's really that much more competitive than what we've been seeing. We feel that we've been seeing that for the last couple of years.

Operator

Your next question comes from the line of Matt O'Connor with Deutsche Bank.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

A couple of unrelated questions. Just first, to follow up on the comment about rolling out a credit card sometime next year. I guess first, is there a current Huntington-branded credit card that somebody else owns in services that you might be able to take back or purchase?

Stephen D. Steinour

There is a credit card that is branded Huntington. We will not be taking it back, however, Matt.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

Okay. So I assume your relationship with that provider ends this year, which is why you can get it next year?

Stephen D. Steinour

That's correct.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

And then just any thoughts on, like the target customer base and how quickly you can grow that and how many you can likely, over time?

Stephen D. Steinour

Well, this is intended to be a customer-focused offering. And we would expect it to at least get to industry norms with that product.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

Okay. And any idea what that means in terms of outstanding, if you had a penetration of, I guess, maybe 20%, 25% which is what some others have?

Stephen D. Steinour

I don't think we've provided any direction on that at this point. It's so far out, Matt.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

Okay. No, it sounds interesting, though. And then just separately, you've rolled out some of these or a number of the in-store branches. You consolidated some of the traditional branches, which obviously will save you some money. Or is there opportunity as you look out the next couple of years to consolidate more traditional branches?

Stephen D. Steinour

Yes, and it's something we look at and we think about as any good retailer would. How can you become more efficient with your distribution?

Matthew D. O'Connor - Deutsche Bank AG, Research Division

All right. Care to share any numbers or not at this point?

Stephen D. Steinour

Not at this point, thank you.

Operator

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

Craig Siegenthaler - Crédit Suisse AG, Research Division

First, just on your near-term strategy in terms of the size of the securities portfolio. We grew a lot in the first quarter. Before that it was declining. I'm just wondering, kind of, what your plans are here. What's driving it? And also, what type of securities have you been adding in terms of duration and also type?

Donald R. Kimble

Craig, this is Don. As far as the securities portfolio, some of that was really related to the timing of the securitization transaction, the build up there, that we would expect our period end balances that we're showing in securities portfolio that migrate more back toward the average position as far as the balances. The duration of our portfolio actually dropped a little bit from the fourth quarter, at end of 3.2 years to the first quarter of 3.1 years. And so, we've been continuing to purchase more of our agency-backed CMOs and other similar structures to what we've had in the past, and so we really haven't changed the mix significantly from the previous quarters.

Craig Siegenthaler - Crédit Suisse AG, Research Division

Okay. And then, when you think about credit quality, generally in the indirect auto business, it seems like it's really benefited from really a robust, kind of, used car market. But if trends do reverse, do you think there's any risk? And this is broadly for the industry of any rep and warranty issues in this market?

Donald R. Kimble

As far as rep and warranties, I don't know that I see used similar to what you would have seen in mortgage that as far as our sales for the securitizations, we really don't have the same type of exposure from a put-back risk perspective there. As far as the expected losses that will model out and also the rating agencies model out in connection with the securitization transactions, don't assume that we'll continue to have the benefit of the stronger used car prices. And so the cume losses that you'll see in the back slides do not reflect the current robust used car prices, and show more of a normalized level. So our expectation is that should not have a significant change to our outlook from that perspective.

Craig Siegenthaler - Crédit Suisse AG, Research Division

And in terms of risk management there, what kind of oversight do you have to make sure dealers aren't filling in the paperworks, saying that, this individual is a teacher or a doctor, and that they're not unemployed. I wondered, kind of, how do you oversee that risk?

Donald R. Kimble

As far as that the risk that we've been in the business for 50 years and we've got very good relationships with our dealers and really take the dealerships that we can have an ongoing trust-based relationship with them. And so, that's really where that confidence starts with, is our client selection and our partnership with those dealerships. Beyond that, we've developed internal score cards that are using historic information that we've been able to accumulate that are helpful for more predictive models. Dan, any other...

Daniel J. Neumeyer

Yes, what I would just say, if there were any kind of trends developing, that would be picked up very quickly because it would start to show up in the credit reports, in the customer scores, et cetera. So not that something like that couldn't ever happen, but I think that our controls would catch it very early on. And obviously, we've not had any experience like that in our long history.

Operator

Your next question comes from line of Ken Usdin with Jefferies.

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

Don, I just wanted to ask you a question about the operating leverage. As you guys are talking about, we'll see it better in the second half of the year, and I'm just wondering if you can help us think about when the jaws really start to occur. And any type of magnitude that you think you're going to be able to deliver, whether it's in terms of a growth gap between percent revenue growth and percent expense growth, or helping us kind of understand at least a point in time at which we really start to see that wedge start to increase?

Donald R. Kimble

Ken, good question. And as far as the operating leverage, we came into this year with all the headwinds we are facing between Durbin and the low interest-rate environment, that if we could have revenues slightly exceed our expense growth given the initiatives that we have in place, that we would have been very pleased. I think the 2% year-over-year -- first quarter-over-first quarter kind of positive operating leverage, is a very good operating leverage for us, and what we hope to see it continuing and showing growth that exceeds the -- a growth in revenues exceed the growth in expenses, and I wouldn't expect it to widen dramatically from there at this point in time.

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

Okay. I would just think that with your continued comments about starting the season, some of the investments that are starting to show that it would actually -- it would naturally improve and widen over time. What would prevent that from happening? Would it just be continuing to reinvest some of it and just kind of managing to it? Or something else that we wouldn't necessarily be able to just see in the operating environment.

Donald R. Kimble

Well, that we will continue to see benefits from the reinvestments. The challenge, I think, that we'll see as far as continued revenue growth at this pace, is that the first quarter did include the securitization transactions, which we'll have twice a year, and it did include much stronger mortgage revenues, including the MSR gain. And I wouldn't want to assume that we're going to have an $8 million link quarter MSR gain every quarter after quarter. And so, those are some of the things that are more cautionary as far as the expansion of that operating leverage.

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

Okay, got it. And my second question is just one -- two small things on credit. Just, you guys mentioned that the provision has kind of gone down to the low end of your range, but obviously we see continued improvement in most of the metrics. I wanted to ask you about two in specific, and we did see a bit of a C&I bump-up, and I know the commentary was that it was made up of smaller credits. I was wondering if you could kind of comment on whether we're seeing some type of seasoning in C&I? And then secondly, the residential mortgage MPs have gone up for several quarters in a row, and I know you've talked about values and such, but any color in terms of -- should that start to improve, given that what we've seen in the unemployment side?

Stephen D. Steinour

Yes, so I guess taking the -- your comment on commercial first. On Page 88, if you look at what the charge-off trends have been over the last year, commercial as a category, actually has been on a -- kind of a nice, steady downward projection. C&I, just last quarter, was up but it was at abnormally low levels the past quarter. So we are going to see some variability from quarter-to-quarter just based on the specific mix of credit. So I don't see any trends there, I think the overall trend will continue to be positive. On residential, that's obviously a continued area of stress, but yes, it goes along with unemployment and home prices. And so we hope to see some stabilization there with the improvement, but that's been one of the stubborn areas that we're working on.

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

Okay. And then, Steve, just one for you on M&A. I know you talked about broad thoughts about size but obviously, you guys just did an FDIC deal. Can you just talk to us about what you guys would be considering or looking at from a broad perspective of what may be less in FDIC land versus regular weight deals, and what's happening as far as the conversation levels about potential sellers out there in the marketplace?

Donald R. Kimble

Well, the FDIC -- the level of FDIC activity, frankly, has been a lot lower than we would have estimated. And it makes, via through the cycle, substantially lower numbers than many would have thought. So I don't think they're at the absolute end of the line in terms of resolutions, but it's not clear that there's any significant additional level of activity in our footprint, and we're only interested in our footprint. There is some level of conversation occurring in a more traditional sense. And it's a little more active at the moment than it might have been the last couple of years, but there is still a wide gulf in terms of value. And I don't think activity necessarily picks up in 2012.

Operator

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

Ken A. Zerbe - Morgan Stanley, Research Division

So you're obviously seeing very, very good growth in C&I, given the resurgence in the Midwest. I guess, my question though, is when the broader economy does start to pick up, is it fair to assume that the Midwest could benefit even more than it is now? Or is the growth right now as good as it potentially could get given a broader economic recovery?

Stephen D. Steinour

We are more bullish on the Midwest, and for a number of reasons. It's -- this energy play between the Marcellus and Utica is going to provide local manufacturers with very, very long-term stable supplies of probably low-cost energy, certainly on a relative basis. And so, we're of a belief that, that's going to continue to expand the manufacturing sector in the footprint. There's a tremendous amount -- additionally, there's just a tremendous amount of investment that's going on in a variety of related areas, education and medical. And it seems to us that there's much more coordinated economic development activity also occurring now of a strategic nature in Michigan, in Ohio and possibly some of the other states we're in, which should be very good for us long-term, as well. So we're bullish on the economic expansion continuing and not just being in a defined early phase.

Ken A. Zerbe - Morgan Stanley, Research Division

Okay. And then the other question I had, in terms of asset yields, I guess, if you look out over the next year or so, are there any quarters where there is any kind of cliff drop in terms of asset yields or loans that reprice and more so than other quarters?

Donald R. Kimble

No, I wouldn't say that there's any cliff quarters. But there are quarters where there's a little higher propensity as far as repayments and renewals, but I wouldn't consider anything cliff or out of the ordinary.

Ken A. Zerbe - Morgan Stanley, Research Division

Okay. And have you matched up the liability sides against those quarters that could see greater repricing?

Donald R. Kimble

That's part of our challenge is managing that asset liability position, and we try to match that up the best we can. Right now, we're slightly asset-sensitive. So if you could do something for us to help get those short-term rates up, that we will be helpful for us. But I think we're pretty well setup.

Operator

Your next question comes from the line of Kevin St. Pierre with Sanford Bernstein.

Kevin J. St. Pierre - Sanford C. Bernstein & Co., LLC., Research Division

On the litigation reserve, could you just give us a little bit more color and perhaps why we should consider that nonrecurring? What drove the increased litigation reserve?

Donald R. Kimble

I don't know that we can provide a whole lot more commentary there, that we did have developments during the quarter on some previously existing cases and that resulted in us taking a fresh look at the reserves that we had established and resulted in a $23.5 million increase. We do review those reserves at least quarterly. As I said, that there were a few developments this quarter that resulted in us wanting to increase this. And again, as far as the issues in sales, they are several years old, and they're not new cases and not new developments that hadn't previously been assessed.

Kevin J. St. Pierre - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And then separately, with a 30-ish percent payout ratio and the announced or proposed share repurchase plan, it would seem as if Tier 1 common, which ticked up 15 basis points this quarter, is probably going to continue to build over the foreseeable future. Can you anticipate a time, or can you think about when and if you might start managing that down and how you would do so?

Donald R. Kimble

Great question. That I think as far as the outlook that we would agree with our announced capital plans, absent any unusual or extraordinary type of events, that we would see our capital ratios flat to up. And as far as managing that down, we'll continue to review that, at least annually, with the regulators as far as our capital plan. We did, between the Fidelity Bank acquisition and the municipal loan purchase, acquire over $1 billion of assets this past quarter. And so, to the extent that there are opportunities for us to continue to evaluate other potential purchases, now that could be one tool that could be useful to help manage that position.

Operator

And your final question comes from the line of Jon Arfstrom with RBC Capital Markets.

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

Just a question on the demographics that you laid out for your in-store customer. It looks like it's a little different kind of customer. And you typically see fee income as a driver rather than credit, but it looks like this is a little bit different. Curious at what you're seeing so far in terms of credit growth out of the in-store branches.

Mary W. Navarro

Well, they're still service branches, so we are doing consumer loans out of those locations. And they're pretty new, so we have -- we've hired all new colleagues, so they're learning a lot of this as we go here, but if you look at our more seasoned locations, they do have pretty solid loan balances on the book. So I wouldn't say that they are more credit-focused versus deposit-focused. We're in a pretty low deposit rate environment right now, so we are seeing -- the biggest thing here, is we're seeing a lot more checking account household growth than what we had anticipated when we started those. So that's proving out to be profitable, as well.

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

That's helpful. Just a quick question on the buybacks, Steve. I don't necessarily want to pin you down on it, but what makes sense in terms of buyback? You said it's stock price-driven. Curious if you view the stock price as attractive here, or are there some other limits that you're taking into account?

Stephen D. Steinour

Well, the board has -- had a lot of time to have robust discussions. There are a number of elements, including market conditions and outlook, but nothing that we're prepared to be more specific with at this time, though.

Todd Beekman

Thank you very much for joining the call. If you have got any other follow-up questions, please feel free to reach out to me, (614) 480-3878. Thank you very much. Have a good day.

Operator

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

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