Huntington National Bank 2005 Annual Report Download - page 130

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS HUNTINGTON BANCSHARES INCORPORATED
risk being hedged, the derivative being used, and how the effectiveness of the hedge is being assessed. A derivative must be highly
effective in accomplishing the objective of offsetting either changes in fair value or cash flows for the risk being hedged.
Correlation is evaluated on a retrospective and prospective basis using quantitative measures. If a hedge relationship is found to
be not effective, the derivative no longer qualifies as a hedge and any excess gains or losses attributable to ineffectiveness, as well
as subsequent changes in its fair value, are recognized in other income.
For fair value hedges, deposits, short-term borrowings, and long-term debt are effectively converted to variable-rate obligations by
entering into interest rate swap contracts whereby fixed-rate interest is received in exchange for variable-rate interest without the
exchange of the contract’s underlying notional amount. Forward contracts, used primarily in connection with mortgage banking
activities, can be settled in cash at a specified future date based on the differential between agreed interest rates applied to a
notional amount. The changes in fair value of the hedged item and the hedging instrument are reflected in current earnings. The
amounts recognized in connection with the ineffective portion of Huntington’s fair value hedging in 2005, 2004, and 2003 were
insignificant. No amounts were excluded from the assessment of effectiveness during 2005, 2004, or 2003 for derivatives
designated as fair value hedges.
For cash flow hedges, interest rate swap contracts were entered into that pay fixed-rate interest in exchange for the receipt of
variable-rate interest without the exchange of the contract’s underlying notional amount, which effectively converts a portion of
its floating-rate debt to fixed-rate. This reduces the potentially adverse impact of increases in interest rates on future interest
expense. In like fashion, certain LIBOR-based commercial and industrial loans were effectively converted to fixed-rate by entering
into contracts that swap variable-rate interest for fixed-rate interest over the life of the contracts.
To the extent these derivatives are effective in offsetting the variability of the hedged cash flows, changes in the derivatives’ fair
value will not be included in current earnings but are reported as a component of accumulated other comprehensive income in
shareholders’ equity. These changes in fair value will be included in earnings of future periods when earnings are also affected by
the changes in the hedged cash flows. To the extent these derivatives are not effective, changes in their fair values are immediately
included in earnings. During 2005, 2004, and 2003, a net loss was recognized in connection with the ineffective portion of its
cash flow hedging instruments. The amounts were classified in other non-interest income and were considered insignificant. No
amounts were excluded from the assessment of effectiveness during 2005, 2004, and 2003 for derivatives designated as cash flow
hedges.
Derivatives used to manage Huntington’s interest rate risk at December 31, 2005, are shown in the table below:
Average Weighted-Average Rate
Notional Maturity Fair
(in thousands of dollars) Value (years) Value Receive Pay
Asset conversion swaps
Receive fixed — generic $ 350,000 2.3 $ (8,782) 3.41% 4.27%
Liability conversion swaps
Receive fixed — generic 1,575,250 5.4 (15,960) 4.21% 4.47%
Receive fixed — callable 665,000 7.2 (19,348) 4.39% 4.22%
Pay fixed — generic 1,301,000 2.1 28,119 4.29% 3.33%
Pay fixed — forward starting 200,000 N/A 2,100 N/A N/A
Total liability conversion swaps 3,741,250 4.5 (5,089) 4.27% 4.00%
Total swap portfolio $4,091,250 4.3 $ (13,871) 4.20% 4.03%
N/A, not applicable
At December 31, 2004, the fair value of the swap portfolio used for asset and liability management was an asset of $17.9 million.
These values must be viewed in the context of the overall financial structure of Huntington, including the aggregate net position
of all on- and off-balance sheet financial instruments.
As is the case with cash securities, the fair value of interest rate swaps is largely a function of the financial market’s expectations
regarding the future direction of interest rates. Accordingly, current market values are not necessarily indicative of the future
impact of the swaps on net interest income. This will depend, in large part, on the shape of the yield curve as well as interest
rate levels. Management made no assumptions regarding future changes in interest rates with respect to the variable-rate
information presented in the table above.
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