In this review below, we show why investment in Huntington Bancshares (NASDAQ:HBAN) can be viewed as a "safe haven" for investors seeking stable income rather than volatile price appreciation. The company offers low cost of risk while maintaining healthy and stable profitability while high level of capital sufficiency underpins dividend sustainability. Proposed merger is very likely to improve company's performance and increase efficiency leading to increase in dividends.
HBAN's stable profit is mostly dependent on interest income (67.5% of total income in 2016Q1). Net interest margin is average (3.11% in 2016Q1, unchanged from FY2015, similar to 3.0% for all US insured banks). Share of noninterest income dropped slightly to 48.1% in 2016Q1 from 53.2% in FY2015 but is still well above the average 40%.
Credit metrics of HBAN are strong. NPL 90+ and non-accrual loans account for just 1.2% of total loan portfolio at end-2016Q1 (growth from 0.95% at end-FY2015). These problem loans are fully provisioned (provision for loan impairment equals 1.2% of loan portfolio, insignificant growth from end-FY2015). Cost of risk amounted just 0.22% in 2016Q1 (0.20% in FY2015) which is very low. Some explanations are as follows.
First, HBAN's exposure to risky sectors is low. In example, company's loans to energy sector amount about 0.5% (with negligible exposure to oil field services companies) of loan portfolio, these loans are collateralized and in first-lien position. Oil prices declined sharply in the last 2 year so such loans are considered particularly risky. Loan portfolio is also granular - according to the company's presentation for 2016Q1 only 5% of loans exceed $50mln. Such granularity ensures that no single borrower bears significant risk for HBAN's capital.
Second, consumer lending which constitute roughly half of the loan portfolio has good quality - 55.7% of loans have 750+ FICO score (mostly mortgages & home equity (58.0%) and automobile loans (39.7%)). Secured loans to individuals are significantly less risky and that's very important when banks face reducing margins and are forced to lower their underwriting standards when competing for borrowers.
Loan to deposit ratio is strong (92.6% and 91.0% and end-2016Q1 and end-FY2015 respectively) mitigating risk of matching debt repayment by marketable investments. Deposits are supported by strong market position in Midwest - for example, in Ohio HBAN takes 3rd place by amount of deposits and has about 12% market share.
M&A activities- there are currently some concerns outstanding in regards with FirstMerit merger (proposed on January 25, 2016, still to be approved by the regulator) which can increase regulatory attention to company - including the requirement to do annual Capital Analysis and Review (CCAR) exercise - and also bear integration risks. But should this transaction be completed successfully S&P expects that "total assets at Huntington will increase by approximately 35%."The deal was priced at 28.8% premium to market prices at end-FY2015.
Dividends. HBAN increased its dividend payout ratio to 32.3% of its net income in 2016Q1 (compared with 29.2% in 2015Q1 and 28.9% in FY2015). Dividend yield of 2.83% is almost 35% higher than average for S&P500 (2.10%). HBAN is well capitalized- total capital adequacy ratio equaled 13.2% at end-2016Q1 (grew slightly from 12.6% at end-FY2015). Given the minimum regulatory requirements of 8.5% this means that HBAN's capital position is sufficient to absorb credit losses even under a much challenging economic environment than it faces currently. Such capacity gives high probability that HBAN will be able to support its payout level at least in middle term.
Significant non-organic growth as a result of merger with FirstMerit should also give economies of scale and allow HBAN to improve its Cost / Income ratio from 65.9% in 2016Q1 (slightly above average for US banks) which will lead to improved margins and higher net income available for distribution to shareholders. Fitch estimates possible "improvement to efficiency ratio of 400 bps" in 2018 (equals just 6% cost reduction, more than reasonable given overlap in key markets such as Ohio and Michigan) which will increase income before taxes by roughly $118mln per year (13.1% as calculated over annualized 2016Q1 data) and should increase dividends given the company will continue to support its payout ratio by raising DPS (last increase was in October, 2015 from $0.06 to $0.07).
HBAN is rated by all 3 main rating agencies - Fitch (rates HBAN at "A-"/"Stable"), Moody's ("Baa1"/"Stable"), and Standard&Poor's ("BBB"/"Stable")
HBAN's earnings are stable as they come mostly from interest on products with quite stable interest income and cost of risk is low. Stable dividend flow is likely to continue in the medium term and can grow as a result of successful merger which is already under regulatory review. Current market price offers an attractive buy possibility (HBAN dropped 12.7% in the last 12 month while S&P500 declined by just 3.6%).
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.