Huntington National Bank 2004 Annual Report Download - page 40

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED
Net Interest Income
(This section should be read in conjunction with Significant Factors 1-6 and 14.)
The Company’s primary source of revenue is net interest income, which is the difference between interest income on earning assets,
primarily loans, direct financing leases, and securities and interest expense on funding sources, including interest-bearing deposits and
borrowings. Earning asset balances and related funding, as well as changes in the levels of interest rates, impact net interest income.
The difference between the average yield on earning assets and the average rate paid for interest-bearing liabilities is the net interest
spread. Noninterest-bearing sources of funds, such as demand deposits and shareholders’ equity, also support earning assets. The
impact of the noninterest-bearing sources of funds, often referred to as ‘‘free’’ funds, is captured in the net interest margin, which is
calculated as net interest income divided by average earning assets. Given the ‘‘free’’ nature of noninterest-bearing sources of funds,
the net interest margin is generally higher than the net interest spread. Both the net interest spread and net interest margin are
presented on a fully taxable equivalent basis, which means that tax-free interest income has been adjusted to a pre-tax equivalent
income, assuming a 35% tax rate.
Table 4 shows average annual balance sheets and net interest margin analysis for five years. It details average balances for total assets
and liabilities, as well as shareholders’ equity, and their various components, most notably loans and leases, deposits, and borrowings.
It also shows the corresponding interest income or interest expense associated with each earning asset and interest-bearing liability
category along with the average rate with the difference resulting in the net interest spread. The net interest spread plus the positive
impact from the noninterest-bearing funds represent the net interest margin.
Table 5 shows changes in fully taxable equivalent interest income, interest expense, and net interest income due to volume and rate
variances for major categories of earning assets and interest-bearing liabilities. The change in interest income or expense not solely
due to changes in volume or rates has been allocated in proportion to the absolute dollar amount of the change in volume and rate.
Table 5 — Change in Net Interest Income Due to Changes in Average Volume and Interest Rates(1)
2004 2003
Increase (Decrease) From Increase (Decrease) From
Previous Year Due To Previous Year Due To
Yield/ Yield/
Fully tax equivalent basis(2)
(in millions of dollars) Volume Rate Total Volume Rate Total
Loans and direct financing leases $ 110.8 $ (75.7) $ 35.1 $ 152.4 $(145.3) $ 7.1
Securities 42.1 (24.7) 17.4 46.7 (46.7) —
Other earning assets 1.4 (10.5) (9.1) 12.7 (2.6) 10.1
Total interest income in earning assets 154.3 (110.9) 43.4 211.8 (194.6) 17.2
Deposits 21.5 (52.7) (31.2) 20.5 (117.9) (97.4)
Short-term borrowings (1.8) (0.9) (2.7) (3.5) (9.8) (13.3)
Federal Home Loan Bank advances 0.3 8.6 8.9 19.0 (0.2) 18.8
Subordinated notes and other long-term debt, including capital securities 21.6 (13.9) 7.7 216.9 (211.7) 5.2
Total interest expense in interest-bearing liabilities 41.6 (58.9) (17.3) 252.9 (339.6) (86.7)
Net interest income before funding cost adjustment 112.7 (52.0) 60.7 (41.1) 145.0 103.9
Funding cost adjustment — 3.7 3.7 ———
Net interest income $ 112.7 $ (48.3) $ 64.4 $ (41.1) $ 145.0 $103.9
(1) The change in interest rates due to both rate and volume has been allocated between the factors in proportion to the relationship of the absolute dollar amounts of the change in each.
(2) Calculated assuming a 35% tax rate.
2004 versus 2003 Performance
Fully taxable equivalent net interest income increased $64.4 million, or 7%, in 2004 from 2003. This reflected the benefit of a 13%
increase in average earning assets, partially offset by the negative impact of an effective 5% decline in the net interest margin to 3.33%
from 3.49%.
The net interest margin declined in the first half of 2004 and primarily reflected the impact from the sale of higher-margin automobile
loans. Such sales totaled $1.4 billion in the first half of 2004 but only $0.2 billion in the 2004 third quarter. The decline in the net
interest margin in the first half of the year also reflected, to a lesser degree, the growth in lower-margin investment securities, as well as
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