Huntington National Bank 2005 Annual Report Download - page 129

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS HUNTINGTON BANCSHARES INCORPORATED
term, variable-rate features and contain clauses that limit Huntington’s exposure to changes in customer credit quality.
Accordingly, their carrying values, which are immaterial at the respective balance sheet dates, are reasonable estimates of fair
value.
Certain assets, the most significant being operating lease assets, bank owned life insurance, and premises and equipment, do not
meet the definition of a financial instrument and are excluded from this disclosure. Similarly, mortgage and non-mortgage
servicing rights, deposit base, and other customer relationship intangibles are not considered financial instruments and are not
discussed below. Accordingly, this fair value information is not intended to, and does not, represent Huntington’s underlying
value. Many of the assets and liabilities subject to the disclosure requirements are not actively traded, requiring fair values to be
estimated by management. These estimations necessarily involve the use of judgment about a wide variety of factors, including
but not limited to, relevancy of market prices of comparable instruments, expected future cash flows, and appropriate discount
rates.
The following methods and assumptions were used by Huntington to estimate the fair value of the remaining classes of financial
instruments:
–L OANS HELD FOR SALE — valued using outstanding commitments from investors.
–I NVESTMENT SECURITIES — based on quoted market prices, where available. If quoted market prices are not available, fair values
are based on quoted market prices of comparable instruments. Retained interests in securitized assets are valued using a
discounted cash flow analysis. The carrying amount and fair value of securities exclude the fair value of asset/liability
management interest rate contracts designated as hedges of securities available for sale.
–L OANS AND DIRECT FINANCING LEASES — variable-rate loans that reprice frequently are based on carrying amounts, as adjusted
for estimated credit losses. The fair values for other loans and leases are estimated using discounted cash flow analyses and
employ interest rates currently being offered for loans and leases with similar terms. The rates take into account the position of
the yield curve, as well as an adjustment for prepayment risk, operating costs, and profit. This value is also reduced by an
estimate of probable losses in the loan and lease portfolio.
–D EPOSITS — demand deposits, savings accounts, and money market deposits are, by definition, equal to the amount payable on
demand. The fair values of fixed-rate time deposits are estimated by discounting cash flows using interest rates currently being
offered on certificates with similar maturities.
–D EBT — fixed-rate, long-term debt is based upon quoted market prices or, in the absence of quoted market prices, discounted
cash flows using rates for similar debt with the same maturities. The carrying amount of variable-rate obligations approximates
fair value.
21. DERIVATIVE FINANCIAL INSTRUMENTS
A variety of derivative financial instruments, principally interest rate swaps, are used in asset and liability management activities
to protect against the risk of adverse price or interest rate movements on the value of certain assets and liabilities and on future
cash flows. These instruments provide flexibility in adjusting the Company’s sensitivity to changes in interest rates without
exposure to loss of principal and higher funding requirements. By using derivatives to manage interest rate risk, the effect is a
smaller, more efficient balance sheet, with a lower wholesale funding requirement and a higher net interest margin. All derivatives
are reflected at fair value in the consolidated balance sheet.
Market risk, which is the possibility that economic value of net assets or net interest income will be adversely affected by changes
in interest rates or other economic factors, is managed through the use of derivatives. Derivatives are also sold to meet customers’
financing needs and, like other financial instruments, contain an element of credit risk, which is the possibility that Huntington
will incur a loss because a counter-party fails to meet its contractual obligations. Notional values of interest rate swaps and other
off-balance sheet financial instruments significantly exceed the credit risk associated with these instruments and represent
contractual balances on which calculations of amounts to be exchanged are based. Credit exposure is limited to the sum of the
aggregate fair value of positions that have become favorable to Huntington, including any accrued interest receivable due from
counterparties. Potential credit losses are minimized through careful evaluation of counterparty credit standing, selection of
counterparties from a limited group of high quality institutions, collateral agreements, and other contract provisions.
A
SSET AND L IABILITY M ANAGEMENT
Derivatives that are used for asset and liability management are classified as fair value hedges or cash flow hedges and are
required to meet specific criteria. To qualify as a hedge, the hedge relationship is designated and formally documented at
inception, detailing the particular risk management objective and strategy for the hedge. This includes identifying the item and
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