Huntington Bancshares Inc. Q3 2008 Earnings Call Transcript

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Huntington Bancshares Inc. (NASDAQ:HBAN) Q3 2008 Earnings Call October 16, 2008 1:00 PM ET


Tom Hoaglin - Chairman, President, and CEO

Don Kimble - EVP and CFO

Tim Barber - SVP of Credit Risk Management

Nick Stanutz -SVP of Auto Finance and Dealer Services

Jay Gould - Director of IR


Ken Zerbe - Morgan Stanley

Matthew O'Connor - UBS

Edward Hemmelgarn

Ryan Randall - Randall Capital


Good afternoon. My name is Mindy and I will be your conference operator today. At this time, I would like to welcome everyone to the Huntington third quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Mr. Gould, you may begin your conference.

Jay Gould

Thank you, Mindy, and welcome, everyone. I'm Jay Gould, Director of Investor Relations for Huntington Bancshares. Topics of the slides we will be reviewing can be found on our website This call is being recorded and will be available as a rebroadcast starting about one hour from the close of the call. Please call the Investor Relations department at 614-480-5676 for more information on how to access these records, recordings for playback or should you have difficulty getting a copy of the slides. Slides 2 and 3 note several aspects of the days a basis of today's presentation. I encourage you to read these

Let me point out one key disclosure. This presentation contains both GAAP and non-GAAP financial measures where we believe it's helpful to understanding Huntington's results of operations. Where non-GAAP financial measures are used, the comparable GAAP financial measure as well a the reconciliation can be found on the slide presentation in its appendix, in the press release, and in the quarterly financial review supplement to today's press release, all of which can also be found on our website.

Today's discussion, including Q-and-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 actual results to differ materially. We assume no obligation to update such statements. For a complete discussion of the risks and uncertainties, please refer to this slide and materials filed with the SEC including our most recent Form 10-K, 10-Q and 8-K filings.

Now, turning to today’s presentation, as noted on slide five, participating today are Tom Hoaglin, Chairman, President, and Chief Executive Officer; Don Kimble, Executive Vice President and Chief Financial Officer; and Tim Barber, Senior Vice President of Credit Risk Management. Also present for the Q&A session is Nick Stanutz, Senior Executive Vice President of Auto Finance and Dealer Services.

Let’s get started. Tom?

Tom Hoaglin

Thank you Jerry and welcome everyone. Turning to slide 6, we are clearly in unprecedented times. The housing sector, the overall economy and the capital markets are all in turmoil. To say the least, uncertainties abound.

So let me begin with some clear messages to our investors and customers about Huntington. First and foremost, we're making money. Granted that our earnings are lower than in more normal times, but we are profitable. Earnings are at a decent level and we expect this to continue.

Second, our balance sheet is strong. Credit costs, as measured by net charge-offs and provision levels, are clearly elevated. In times like these that's to be expected, but even so, they're manageable and our loan loss reserve level was both increasing and sound. Our capital levels are strong. Our regulatory capital position is around $1 billion more than the well-capitalized regulatory thresholds.

Our capital ratios increased this quarter. Our tangible capital assets ratio is now back in our 6% to 6.25% targeted range. Our funding capacity is well-positioned. There's ample cash at the holding company level. We have a very manageable level of debt maturities at the bank level during the next 12 months, which we'll be able to handle without having to access the capital markets and we have no holding company debt maturities for several years.

It's also important to note that our local bank and relationship-driven business model is proving to be a competitive advantage. Underlying activities are performing well, as Don will detail for you. More important is the fact that we know our markets and our customers well. In 2001, we rededicated ourselves to staying in our Midwest markets and to strengthening our customer relationships.

Staying close to home helped us to avoid the temptation to chase growth outside in unfamiliar markets, that are having a disproportionate amount of difficulties these days. By focusing on developing and nurturing customer relationships, be they individuals or businesses, we have seen customers demonstrate their competency and loyalty to Huntington in these uncertain days. For example, this past quarter we grew core deposits at a 4% annualized rate. Their loyalty has been appreciated. They know we will continue to work with them through out these difficult times.

Turning now to our review of the quarter, slide 7 outlines today's discussion. I'll begin with my usual overview of performance results. As we did last quarter, Tim Barber will follow with a review of credit trends and a detailed discussion of our key loan portfolio segments. Don will follow with an abbreviated earnings performance review and spend most of his time discussing our capital position and expectations. He will conclude with an update of our 2008 outlook. I'll close with summary comments followed by Q&A.

Turning to slide 8, reported earnings were $0.28 per share, which benefited by a net $0.01 from significant items, which Don will detail for you. With regard to credit quality performance, it was basically as advertised in our last quarterly conference call. Net charge-offs were 82 basis points and consistent with our expectations that net charge-offs would rise in the second half of this year, following reserve increases in the first half of the year.

Our allowance for credit losses increased 10 basis points to 1.90%. As expected, this was less than the 13 basis point increase in the second quarter. Non-accrual loans increased 10%, down from a 42% increase in the second quarter. And non-performing assets increased 5%. Commercial loans increased at a 4% annualized rate and while consumer loans declined at a 5% annualized rate, this mostly reflected the impact of second quarter mortgage loan sales.

Our exposure to Franklin declined $36 billion, or 3%, as collateral cash flows continued to exceed that required by the 2007 fourth quarter restructuring. As I mentioned, core deposits increased at a 4% annualized rate. This reflected good growth in consumer core deposits, primarily core certificates of deposit.

Our Tier 1 and total risk based capital ratios both increased and our tangible equity ratio is now 6%, back in the target range of 6 to 6.25. Expenses continued to be very well-controlled, primarily reflecting a decline in staff due to merger efficiencies, with our efficiency ratio now down in the low 50s range.

Fee income performance was not as good as expected. Many fee-based activity levels declined given the economic environment and lower market valuations decreased the value of managed assets.

But all in all, under the present circumstances a good quarter, with higher earnings per share than in the second quarter. I will let Don elaborate on these overview comments later in the presentation. Now let me call on Tim Barber to review our credit quality trends, individual performance, and portfolio performance. Tim?

Tim Barber

Thanks, Tom. I'm going to start with an update of our perspective on the Franklin’s credit relationship, given the announcement of one of our co-lenders yesterday.

Turning to slide 9, the Franklin credit relationship continued to perform as agreed. We are aware of the actions taken by one of the other participants in the credit, but believe that their actions nearly brought them more in line with our view of the collateral performance. We have been very upfront with our credit performance assumptions over the course of the past year and continue to watch the actual performance very closely on a real-time basis.

Turning to slide 10, the monthly cash flow has been above the required debt service, allowing for accelerated principal paydowns of nearly $60 million for the first nine months of the year. As you can see, the absolute level of cash flow declined in the third quarter. Franklin has continued to actively work the portfolio as evidenced by the number of accounts moving into their modification status in the second quarter results.

Given the current market dynamics, we fully expect the performance of the underlying collateral to continue to be negatively affected. But we remain convinced that the Franklin servicing platform is operating well, and we have appropriately sized the debt and reserves relative to anticipated collections. We remain comfortable that our credit assumptions regarding the overall portfolio performance are appropriately conservative. Let me review them quickly.

As you recall, our probability of default assumptions of 70% for Tribeca and Franklin first, and 65% for Franklin second, remain conservative when compared with Franklin's actual performance. As recoveries in general and OREO net proceeds in particular make up a larger portion of total collections, it is important to note our recovery assumptions of only 10% for Franklin purchased second, 60% for Franklin purchased first and 90% for Tribeca originated loans. We continue to monitor cash flow closely but believe these recovery assumptions remain appropriate. As a reminder, we have charged off or forgiven $397 million and have an additional reserve of $115 million on our portion of the debt.

Slide 11, provides an overview of our credit quality trend. Overall, the quarter was much as anticipated from a credit quality standpoint. First, as noted, the entire Franklin relationship continued to perform as agreed, and continues to accrue interest. Our non-accruing loan level increased 10% during the quarter, compared with a 42% increase in the second quarter. I'll provide additional detail on the non-accruing loan levels on a future slide.

Our net charge-off ratio was consistent with our expectations for higher charge-offs in the second half of 2008 based on the reserve build in the first half. Again, I will provide some detail on a portfolio level basis later in the presentation.

Our 90 plus past due and accruing levels were higher in the C&I and CRE portfolios. By definition, these commercial loans are either well-secured or in the process of collection, so significant additional non-accruals from these loans are not expected. Of the total 90 plus day past due level at September 30th, $20 million is no longer 90 days past due.

On the consumer side there was a reduction for the second consecutive quarter in the home equity portfolio delinquencies. This is consistent with our belief that 2008 will represent the high water mark for losses in this portfolio. Indirect auto delinquencies were slightly higher, reflecting the seasonality inherent in the auto book.

The residential mortgage portfolio delinquencies increased in the quarter after a decline in the second quarter. In the consumer segments, there is a high correlation between the 90 plus day past due level and charge-offs in future periods. These trends are consistent with our expectations for performance in the consumer segment.

As Tom noted, the economic environment continues to be very difficult. But there are areas where we are pleased about the performance. As the environment has changed, we have continued to build our reserve levels appropriately, with our allowance for credit losses or ACL ending the quarter at 190 basis points. The non-accrual coverage ratio is now 134%, and we continue to view the reserve level as adequate. It is important to remember that as we identify new non-accruals, we conduct a formal impairment test that could result in either additional specific reserves or a write-down of the balance. A significant portion of the increase in the ACL has been a result of this impairment testing process. We are comfortable that we have taken appropriate action on the non-accruals.

Slide 12 provides the detail associated with the increase in the non-accrual loan level. As you can see, the majority of the $51 million increase was centered in the C&I and CRE portfolios, with single family home builder accounting for $26 million or over half of the increase. Increase was a function of a number of small relationships, as only two were over $5 million. The activity was not centered in any one specific region, though it was a bit more concentrated in Northern Ohio. The residential real estate segment showed a modest increase in the quarter while the home equity levels declined slightly.

Turning to the entire loan portfolio, Slide 13 details our portfolio distribution in annualized growth rate. The commercial real estate portfolio growth was centered in the Pittsburgh and Cincinnati and was not connected to single family home builders. The credit profiles of our new borrowers are strong reflecting the commitment to establishing relationship with the top commercial real estate developers in each region. There was growth in the retail segment, but the majority was centered in traditional income producing property types such as multifamily, office and warehouse.

The growth in our auto loan portfolio has been a constant for us in 2008, and we remain committed to originating loans to prime borrowers. We did show growth in home equity loans as borrowers moved into the home equity line of credit products given the lower rates currently available. We have seen an increase in the number of borrowers using this product secured by a first mortgage. This segment of borrowers performed extremely well. We have seen only a small increase in funding on existing lines.

The decline in residential mortgages reflected the significant loan sale we closed in the second quarter. As I did last quarter let me now address each individual portfolio from a credit quality standpoint in more detail.

Turning to slide 14, regarding commercial real estate, the credit issues continue to be concentrated in the single family home builder segment. We remain comfortable with our full year forecast for net charge-offs of 60 to 70 basis points, and have actually reduced this targeted range based on actual year-to-date performance.

Slide 15 and 16 provide additional detail on the single family home builder segment. Please note the granularity of the portfolio with only 15 projects over $10 million in outstanding. The performance of the portfolio does continue to show the negative impact of the continued difficult market.

On slide 16 we show the five quarter trend of the primary asset quality metrics. Nearly two thirds of the increase in 30 plus delinquencies is associated with loans that have contractually matured, but where the renewal or rewriting process has not yet been completed. In this economic climate we are being very careful in the renewal decision process in order to assure an appropriate structure for the bank.

As we have previously communicated, we are not in the business of extending additional credit from our interest reserves in order to prevent delinquencies. We do, however, work diligently with our borrowers to create structures that offer the bank additional security, while keeping the customers and/or projects in business. We have clearly increased the reserve associated with the portfolio and reaction to the changes, and anticipate further increases in the future.

Slide 17 and 18 detail our exposure to the commercial real estate retail segment. The overall portfolio continues to perform well given the market. The increase in classified loans was spread among a number of projects unlike the first quarter change that was driven by one large credit. We did show an increase in outstanding, as existing commitments to high quality borrowers and projects continued [default].

Regarding the C&I portfolio, slide 19 shows this is a very granular portfolio. We have already discussed the increase in non-accrual loans, which you will recall was influenced by a small number of credits. The loan production was heavily concentrated in additional loans to existing customers as we continue to focus on serving our ideal Huntington client.

Regarding the $1.6 billion shared national credit segment of our C&I portfolio, our credit quality metrics are substantially better than the industry level results announced last week by the office of the comptroller of the currency. This testifies to our commitment to quality underwriting and client selection. The OCC comment that the negative trend in shared national credit performance was a result of loans used to “support highly leveraged merger and acquisition transactions originated in 2006 and 2007, that are characterized by weak underwriting standards,” and does not apply to the Huntington shared national credit portfolio or the rest of our portfolio for that matter.

Turning to slide 20, we continue to experience excellent origination trends in the first nine months of 2008 in our indirect auto portfolio. Given some recent announcement by others regarding the sector, we continue to want to clearly differentiate our portfolio performance and strategy from others in this business. As the portfolio performance changed over the course of 2007, we made adjustments to our underwriting processes and monitoring approach.

We also increased our average FICO score and reduced the proportion of less than 670 borrowers. We also increased releases of our custom score card to further differentiate the risks even within the higher FICO score ranges. We have raised the full year net charge-off expectation slightly, primarily as a result of the auto lease portfolio, as our auto loan portfolio has continued to perform very close to expectations.

Slide 21 provides an overview of our home equity loan portfolio. The first item to discuss is a change in our reported net charge-offs from the prior quarter. During the third quarter it was determined that some charge-offs classified in our other consumer portfolio were actually home equity losses. The results shown here reflect that reclassification. As a result, previously reported net charge-offs for other loans decreased, and those reported for home equity loans increased.

This reclassification had no impact on the overall Huntington reported charge-offs. The reclassified first and second quarter results were 84 and 94 basis points respectively, compared with 85 basis points in the third quarter. Even with the reclassification, these levels remain materially better than the industry as a whole.

The full year forecast has been changed only slightly to reflect the reclassification. Our view of the home equity portfolio performance is only marginally different today than at the end of last quarter. Our vintage analysis continues to indicate stable portfolio performance and our percentage of broker originations continues to decline.

Slide 22 outlines the origination strategies we have employed over the years associated with residential mortgages. As it relates to performance comparisons with the industry I have presented them in order of importance. Our exposure is concentrated in our footprint, with the vast majority originated directly by a Huntington banker and using generally traditional product structures. We have heard this message in the past but it bears repeating, as we continue to believe that these decisions will continue to allow us to report better than industry credit quality results.

Slide 23 provides some detail on the residential mortgage origination and performance. We continue to be comfortable with our full year loss estimates for the portfolio. The Alt-A segment represents 35% of expected full year 2008 losses. As we have noted, we no longer originate this product, and the balances are running off. The adjustable rate mortgage segment represents 70% of the total residential mortgage portfolio and has a current loss factor of less than 20 basis points.

Slides 24 and 25 provide a summarized view of our first quarter and nine months, and updated 2008 full year net charge-off expectations by segment.

That concludes the credit discussion. Let me turn the presentation over to Don who will discuss our first quarter financial performance.

Don Kimble

Thanks, Tim. Turning to slide 26, our reported net income was $115.2 million, or $0.28 per common share, for the quarter. These results were impacted by two significant items. First, we had $11.8 million, or $0.02 per share, of net market-related gains consisting of the following items: $21.4 million of gains from the extinguishment of debt as we discussed during our second quarter earnings call; $3.7million of equity investment gains; $1.9 million of positive impact from the revaluation of mortgage servicing rights, net of hedging. This was offset by $15.2 million of net losses from investment securities, which included $17.9 million of impairment on certain asset backed securities.

Second, $3.7 million, or $0.01, deferred tax valuation allowance adjustment representing an increase to the previously established capital loss carry forward valuation allowance related to the Visa stock held by Huntington. In other words, our income tax expense went up by $3.7 million for this issue.

Slide 27 provides a quick snapshot of the quarter's performance. As previously noted our net income was $0.28 per share. Our net interest margin was 3.29%, stable with the second quarter. This performance reflected better pricing on loan products, offset by more aggressive deposit [rising] in our region for this quarter.

Average total commercial loans increased at a 4% annualized pace. This growth was comprised of new and increased loan facilities to existing borrowers. Average total consumer loans were down slightly from the prior period, reflecting the impact of the mortgage loan sale late in the second quarter.

Average total core deposits were up at a 4% annualized rate, reflecting the growth in consumer time deposits, more than offsetting a reduction in certain non-relationship collateralized deposits. These collateralized deposits provide little incremental margin and letting them run off allowed us to reduce the corresponding in investment security balances.

Our fee income performance during the quarter reflected the impact of financial markets in several key categories. Mortgage origination fee income was down about 42% due to lower origination activity. Market driven reductions and asset values also resulted in a 6% reduction in trust fees.

Expense levels were down 2% from the second quarter after adjusting for operating lease expense, merger costs and the significant items noted before. This decrease resulted in an adjusted efficiency ratio of 53%, approaching our long-term target of 50% to 52%. As Tim noted earlier, our annualized net charge-off ratio was 82 basis points, bringing our year-to-date annualized net charge-off level to 65 basis points.

We'll discuss our capital ratios in much more detail in a moment, but it's important to note that our Tier 1 total capital ratio of 8.9% and our total capital ratio of 12.1% were both up from June 30th levels.

Slide 28 shows the trends in both the reported and adjusted efficiency ratios over the last seven quarters. The adjusted ratio excludes the impact of operating lease accounting and the impact of other items affecting comparability including merger costs. These adjustments are detailed in the appendix of our slide deck.

The adjusted ratio is showing a very positive trend, decreasing from 59% to 53% over the last seven quarters, and clearly reflecting the benefit of the expense and revenue synergies from the Sky acquisition. This improvement was accomplished despite the impact of much higher collection costs and the impact of market volatility.

Slide 29 provides a summary of many of the quarterly performance ratios. Most of these have been reviewed in more detail elsewhere, so let's move on. Slide 30 shows a snapshot of our asset backed investment security portfolio. The two components that have had the greatest market volatility are the Alt-A mortgage backed securities and the pool of trust preferred securities.

This quarter we recognized $17.9 million of impairment on two of the 24 securities held in our Alt-A mortgage backed securities portfolio. Each quarter we analyze projected cash flows for all of these securities. This quarter our estimates projected an average principal cash flow shortfall of less than 3% for these two securities or about $1.6 million over the remaining life of these bonds. Yet with a 3% projected shortfall, we are required to deem the bonds to be impaired resulting in a mark-to-market impairment of almost $18 million.

The difference between the $1.6 million shortfall and the $17.9 million impairment will be accreted in the income over time. Our full review of the pooled trust preferred portfolio indicated recovery of all principal, and accordingly no other than temporary impairment was recognized for this portion of the portfolio. We continue to monitor all these bonds very closely, using the assistance of third parties to validate our assessment.

Slide 31 provides a review of our liquidity position. Our holding company has sufficient cash for operations. The only significant demand on that cash represents $60 million of common preferred dividends per quarter. We do not have any holding company debt maturities until 2013 and then it's only $50 million.

We've also conservatively managed the liquidity position of our bank. An auto loan securitization and a mortgage loan sale freed up over $1.3 billion of liquidity late in the second quarter. These actions leave us with a very manageable $1 billion of national market maturities over the next 12 months. These maturities can be met through core deposit growth, FHLB advances and normal national market funding sources including broker deposits and auto loan securitization.

Like everyone else we’re in the process of evaluating the impact of the FDIC's temporary liquidity program. We estimate that about $800 million of our maturities qualify for consideration under the program, which would result in a potential issuance capacity of approximately $1 billion.

Turning to slide 32, we provided a summary of our capital ratios for Huntington and peer banks. Since no peers had announced their third quarter Tier 1 and total capital ratios, we're showing the ratios as of June 30th as an initial benchmark. You can see that Huntington has the sixth highest Tier 1 and seventh highest total capital ratio with both being significantly higher than regulatory thresholds for well capitalized.

Last quarter we provided a stress test scenario for our capital levels. Slide 33 provides an updated stress [scenario] summary based off September 30th positions. It is important that you understand the numbers shown on this slide are for analytical purposes only. We're not making any long-term forecast, nor should you consider any of these assumptions as guidance. This is a simple what-if analysis to test the sensitivity of our capital levels to various net charge-off scenarios only.

With those caveats, this stress summary uses the following assumptions: 2% annualized asset growth, and an earnings base case level of $1.15 of EPS over the next four quarters. We chose this as it represents the most recent Street estimate for our 2009 EPS. An assumption that dividends are held constant at a current quarterly rate at a [13.25 cents] per share and there are no new capital issuances.

A base case assumption that net charge-offs over the next 12 months average 82 basis points, an amount equal to third quarter performance. And no additional changes to our accumulated other comprehensive income. With these assumptions, the base case shows our Tier 1 capital ratio improving over the next four quarters by about 10 basis points per quarter or about 40 basis points over the next 12 months to about 9.3% from now.

To stress this base case result we assumed our net charge-off ratio would double to a 164 basis points with our provision expense increasing by the amount of the change in net charge-offs or about $345 million pre-tax. Under this stressed scenario, our Tier 1 capital ratio remains relatively flat.

Tripling that charge-offs to 246 basis points would result an additional pre-tax provision to 260 million dollars. Again, assuming no other changes to our dividend or additional capital issuance our Tier 1 capital ratio would decline by only 40 basis points to 8.5%, in line with the current peer averages and would remain significantly above the regulatory well capped capitalized thresholds.

Projections for the tangible equity ratios are consistent with the result of the Tier 1 stress scenarios. Our tangible equity ratio increases by 40 basis points in the base case, is flat in the first stress scenario, and declines only 40 basis points in the severe stress scenario. This clearly reinforces our case that our capital levels and our dividend payout levels are well positioned for this period of stress in these financial markets.

Turning to slide 34, we provided additional detail to help analyze our earnings guidance. As you know, when earnings guidance is given, it is our practice to do so on a GAAP basis unless otherwise noted. Such guidance includes the expected results of all significant forecasted activities. However, guidance typically excludes selected items where the timing or the financial impact is uncertain, until this impact can be reasonably forecast, and it excludes any unusual or one-time items as well.

We are adjusting our 2008 earnings guidance to $1.12 to $1.16 per share. We anticipate the economic environment will continue to be negatively impacted by weaknesses in residential real estate markets and however interest rates may change we expect to maintain a relatively neutral interest rate risk position.

Given this backdrop, here are our outlook comments. Revenue growth relatively stable with the third quarter level adjusted for some the items. This is expected to reflect a net interest margin flat with the third quarter level of 3.29%. Annualized average commercial loan growth in the low single-digit range with total consumer loans being down slightly. Core deposit growth in the mid single-digit range and non-interest expense being relatively stable. Also, non interest income is expected to be relatively stable with the third quarter level as well.

Regarding credit quality performance, we anticipate a full year net charge-off ratio of approximately 70 to 75 basis points implying fourth quarter net charge-offs of between 90 and 110 basis points. We anticipate that the allowance for credit losses will also increase 5 to 10 basis points from its September 30th, 1.9% level. Again all this resulted in a targeted reported EPS for 2008 earnings of $1.12 to $1.16 per share. Tom?

Tom Hoaglin

Thanks Don. Before wrapping this up, there are two other issues to cover. First, effective with 2009 reporting, we're changing our earnings guidance practices. We will continue our practice of providing robust qualitative forward-looking comments regarding all the key earnings drivers. This includes such things as net interest margin, loan and deposit trends, fee income and expense growth expectations, credit quality trends, capital trends, the impact of changes in the economic environment and the like, but consistent with much of corporate America these days, we'll no longer provide specific earnings per share target.

Second, I want to comment on recent government actions to stabilize the credit markets and assist banks. These actions include the Emergency Economic Stabilization Act of which the $700 billion Troubled Asset Relief Program, or TARP, is the centerpiece.

This week, further announcements were made including the plan to take equity interest in banks. The FDIC announced a temporary liquidity program, where it extended FDIC guarantees to certain unsecured senior debtor banks, as well as the safety deposits beyond the $250,000 threshold.

So what are we to make of all this? First of all, we applaud these bold actions as we believe they will help address the challenges facing many banks and their customers. Given time they should be helpful in stabilizing the economy and markets by assisting banks with troubled assets and liquidity challenges. However, we don't know yet what impact if any of these actions will mean specifically for Huntington. It's simply too early to assess these until all of the regulations, rules, and mechanics of the plans have been defined.

Any comments today would be speculation and could unintentionally set false expectations, but we can say definitely that, if there is a way these programs can provide long-term benefits for our shareholders, we will certainly give them serious consideration.

We have covered a lot of ground in a short period of time, so, let me recap the key points. We feel very good about our underlying business performance. We are tracking new customers. Our net interest margin remains relatively stable. Loans and core deposits are growing and we continue to focus on controlling unnecessary spending and we remain satisfied with the performance of our loans to Franklin credit while remaining interested in eventually exiting the relationship.

Our balance sheet is strong in all its aspects. This includes loan loss reserves, capital with our funding and liquidity position. Credit quality performance is a challenge. The prolonged downturn will keep pressure on us to build reserves, and it continues to move the needle up a bit on net charge-off expectations. But while the net charge-offs and provision are elevated, they're manageable. We continue to believe that actions we have taken over the last several years to reduce risk in our loan portfolios will result in our credit quality performance over this cycle comparing better relative to many of our peers.

Lastly, we expect 2008 will be a successful and profitable year with fourth quarter earnings targeted to be inline with third quarter performance. We remain as focused as ever on delivering results and convincing investors that our stock price today is far below its true value.

Operator, we'll now open it up for discussion to questions.

Question and Answer Session


(Operator Instructions) Your first question comes from Ken Zerbe of Morgan Stanley. Your line is open.

Ken Zerbe - Morgan Stanley

Thank you. First question is on Franklin. I was hoping you would review the cash flow trends a little bit there. Just in a little more detail. I saw the presentation. It does appear that they are still well above your, total cash flow expectations, but the difference does seem to be coming down quite sharply. At what point do you have to go back and re-evaluate this?

If you could also just talk about the actual covenants that you have with Franklin because actually I thought I read through the covenants and it did not seem it was on a total cash flow basis but yet it was on, say, an interest coverage basis. Just if you could go into that, that would be great.

Tom Hoaglin

Ken, I am going to ask Tim Barber to respond to you.

Tim Barber

Ken, there are a lot of questions in there. The first one would be clearly the cash flow has declined over time. We are focused more on the relative stability over the last six months than comparing it to a year ago or even very early 2008 numbers. As the portfolio declines, the cash flow will also fall.

We are also looking at the OREO segment or the recovery segment as a significant piece of future cash flows. That is not necessarily reflected in the current levels and that again is a function of the performance over time. They are focused on working the OREO properties or the defaulted properties through the system. So that is one of the reasons we continue to feel comfortable about the cash flows.

Tom Hoaglin

Just to interrupt, Tim for a minute here, what we are experiencing and I feel quite certain others around the country are and what Franklin is experiencing is a court system that is just engulfed in paperwork from lenders trying to gain control and sell properties. So there has been a bit of a slowdown in collections from OREO. That does not mean that the collections will not be achieved. It just has changed a bit, the timing of those over the last few months. Tim?

Tim Barber

Yes, I think that is fair and we were pleased to see the amount of OREO proceeds increase in the month of September relative to July and August within the third quarter. As it relates to the covenants in the agreement, the original covenant was an interest coverage ratio. The more current covenants reflect total cash collections versus debt service requirements.

So when will we have to re-evaluate? We evaluate on an ongoing basis and are comfortable right now. Certainly if there was a material difference in performance going forward or we changed our projections going forward, we would have to re-evaluate the covenants under which the relationship operates.

Ken Zerbe - Morgan Stanley

Okay, so, just to be clear on that, so you have completely scrapped the interest coverage covenants and have moved purely to a total cash flow basis?

Tim Barber

The covenants are total cash flow. Obviously we continue to be focused on what the interest coverage is within that overall cash flow coverage.

Ken Zerbe - Morgan Stanley

Of course, okay. Then I just want to make sure I read this chart correctly that as of September 2008, the principle and interest that you were collecting, if we just look at principle and interest coming from Franklin, that was insufficient to meet their required principle and interest and expenses payments to you, but there they are making up the difference in cash flows by just selling their real estate? I mean, is that the right way to read that chart?

Tim Barber

Chart 10 represents the entire Franklin credit relationship. That does not represent Huntington's portion of it. So, the principle and interest collections were essentially exactly what the debt service coverage plus servicing costs was for the month of September.

Ken Zerbe - Morgan Stanley

Okay. Then the last question I had, could you just comment a little bit about what might be the differences in your Franklin exposure versus M&I, you reported yesterday and I know, M&I actually wrote down its Franklin exposure during the quarter but you did not and I was curious, why the difference there?

Tom Hoaglin

Ken let me just say, this is Tom, do you think that M&I has done what we have done with this exposure in the past? So just harkening back to what Tim said earlier, we believe that our reserving position has been conservative from the outset and that you may see that in the light of catching up to where we have been. So please do not judge us based upon the actions of others. Tim?

Tim Barber

Yes, I cannot get to exactly what M&I did. I can say that we continue to believe that the way we are assessing the risks in the underlying collateral portfolio is conservative and we believe the reserve that we have established for our exposure is appropriate.

Ken Zerbe - Morgan Stanley

Okay. That was very helpful. Thank you very much.


Your next question comes from Matthew O'Connor UBS. Your line is open.

Matthew O'Connor - UBS

Hi everyone.

Tom Hoaglin

Hi, Matt.

Matthew O'Connor - UBS

Do you know or think that Huntington will be able to qualify for the treasury capital?

Tom Hoaglin

We will let you know on November 14th, Matt. That is the deadline for communication, as you might know, to the treasury with regard to participation. We are at present still trying to gather information about various programs and that is I think an accurate representation of the status from Huntington's viewpoint.

Matthew O'Connor - UBS

Okay. Then assume that you are eligible; do you view at this point taking the capital as a sign of strength or weakness? I think there is a lot of debate over that?

Tom Hoaglin

Because there is a lot of debate on it, it would be great for us to update you on or about November the 14th. We are all going to learn a lot between now and then, I think.

Matthew O'Connor - UBS

Fair enough. Maybe switching to a different topic here. A couple years ago you talked about tightening the underwriting standards in home equity and auto, and I think a lot of us, including myself, were doubtful that your home equity losses would level off, which they have done. Now, as we look out from a broader perspective, the economy seems like it is going to be a lot weaker than we would have thought just a few months ago. So what are you doing differently, say specifically, in the commercial and non-residential commercial real estate books?

Tim Barber

I think we are not doing anything differently today than we were not doing six to 12 months ago. We have continued to focus on top tier developers in the real estate world and that has gotten a lot of play publicly. We have essentially exactly the same commitment on the C&I side which is to deal with high quality customers.

Tom Hoaglin

I think, Tim, it is safe to say that our underwriting, for example, in the CRE world, was never the same underwriting that some wrote for conduit purposes. We have always been and continue to be much more conservative than that.

Tim Barber

Yes, I think that is a great point in the commercial real estate portfolio specifically. There were deals getting done at 1.05% times debt coverage. That is been something that Huntington just never engaged in. So I think we have always had a higher credit quality standard than the market in general. So, continuing that focus and sharpening that focus maybe in times of economic upheaval or economic distress is where Huntington is related to the commercial world.

Tom Hoaglin

By no means are we without blemish. Let's be perfectly clear about that. We certainly made some mistakes along the way but I really do believe that our fundamental approach to underwriting in the commercial environment stands pretty well as we move into this period of time.

Matthew O'Connor - UBS

Okay, thank you.

Tim Barber

Operator, can you disconnect that line?


Unidentified Analyst

Currently the regulators in some or all states may take a number of possible corrective actions in response to our noncompliance including license revocation and/or suspension, etcetera. I know you have filed an 8-K that made reference to this, but just wanted to see the status of that and make sure that all of that has been solved.

Tim Barber

This is Tim Barber. The status of that is that Franklin continues to operate in all of the states. That was a preliminary view from the company's standpoint a worst case scenario. That has proven to not be an issue for them.

Unidentified Analyst

So it is been fully resolved?

Tim Barber


Unidentified Analyst

Okay. Thank you.


Your next question comes from Edward Hemmelgarn, your line is open.

Unidentified Analyst

Yes, I just wondered if you could maybe discuss a little bit of trends that you might be seeing or you might expect to see in net interest margins over the next 12 months, given the additions of liquidity that have been added and the steepening of the yield curve.

Don Kimble

Edward, this is Don. I can go ahead and take a first crack at that. I think with the improvement in the liquidity position, we are hoping that we will see some improved deposit pricing throughout our footprint and that is been one of the main reasons why we did not see a significant lift to our margin over the past quarter. So we are hoping to see as we said in our guidance stable margins. That would assume more of the same environment that we have been experiencing and any additional benefit from enhanced liquidity position should help to widen that spread.

Unidentified Analyst

Okay. Thanks.

Don Kimble

Thank you.


Your next question comes from Ryan Randall of Randall Capital. Your line is open.

Ryan Randall - Randall Capital

That is okay, my question was answered.

Tom Hoaglin

Thanks Ryan.


(Operator Instructions)

Jay Gould

Okay, Operator, that there are no other questions. Well, thank you everybody for participating in today’s call. Jack and I stand by to answer any follow-up questions that you may have. Thank you.


This concludes today's conference.

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