Huntington National Bank 2005 Annual Report Download - page 80

MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED
Dealer Sales
(See Significant Factors 1 and 3 and the Operating Lease Assets Section.)
Objectives, Strategies, and Priorities
Our Dealer Sales line of business provides a variety of banking products and services to more than 3,500 automotive dealerships
within our primary banking markets, as well as in Arizona, Florida, Georgia, North Carolina, Pennsylvania, South Carolina and
Tennessee. We have been in this business for more than 50 years. Dealer Sales finances the purchase of automobiles by customers
of the automotive dealerships, purchases automobiles from dealers and simultaneously leases the automobiles to consumers under
long-term leases, finances the dealerships’ floor plan inventories, real estate, or working capital needs, and provides other banking
services to the automotive dealerships and their owners. Dealer Sales is directly impacted by general automotive sales, including
programs initiated by manufacturers to enhance and increase sales directly. Competition from the financing divisions of
automobile manufacturers and from other financial institutions is intense.
Dealer Sales’ strategy has been to focus on developing relationships with the dealership through its finance department, general
manager, and owner. An underwriter who understands each local market makes loan decisions. Maintaining pricing discipline is
a higher priority than simply increasing market share. In 2005, total vehicle sales expanded 1.5% domestically, yet the number of
vehicles we financed fell 18%, as we chose to maintain disciplined pricing. As a result, our market share fell in nearly all of our
markets, though we maintained our market rankings among our bank competitors.
In 2003, we established a goal to reduce credit exposure to automobile financing. To reduce this credit exposure, while increasing
our service levels provided to the dealerships, we sold a portion of our originated loans. As a result, at the end of 2005, only 18%
of total credit exposure was to automobile financing. To maintain this level of automobile financing exposure, we expect to
continue selling a portion of our on-going loan production.
Automobile lease accounting significantly impacts the presentation of Dealer Sales’ financial results. Automobile leases originated
prior to May 2002 are accounted for as operating leases, with leases originated since April 2002 accounted for as direct financing
leases. This accounting treatment impacts a number of Dealer Sales’ financial performance results and trends, including net
interest income, non-interest income, and non-interest expense. Residual values on leased automobiles, including the accounting
for residual value losses, are also an important factor in the overall profitability of automobile leases.
2005 versus 2004 Performance
Dealer Sales contributed $67.2 million, or 16%, of our net operating earnings for 2005, up $1.5 million, or 2%, from 2004. This
primarily reflected the benefit of a $138.3 million decline in non-interest expenses and an $18.7 million reduction in the
provision for credit losses, partially offset by a $154.6 million, or 33%, decrease in fully taxable equivalent revenue. The decreases
in revenue and expenses were driven by the decline in the operating lease portfolio, as operating lease income declined
$152.4 million and operating lease expense fell $131.2 million. Dealer Sales’ ROA was 0.99%, down slightly from 1.01% in 2004,
with a ROE of 18.9%, up from 16.1% in 2004.
The $154.6 million decrease in revenues reflected a $152.4 million decline in operating lease income as that portfolio continued
to run off. The remaining $2.2 million decline in revenue reflected a $4.2 million, or 3%, decrease in net interest income,
partially offset by higher fee income. Net interest income declined primarily as a result of pricing pressure that pushed the net
interest margin down 8 basis points from 2004, as total average loans and leases declined only slightly. Though funding costs rose
steadily throughout 2005 as interest rates increased, competitive pressures resulted in the inability to pass these higher funding
costs directly to consumers in the form of higher loan and lease rates. This resulted in narrower margins on automobile loan and
lease originations in 2005 compared with 2004.
Average total loans declined $30 million from 2004, but there were significant changes in the loan mix. Specifically, average
automobile loans declined $241 million, or 11%, reflecting a 5% decline in automobile loan production, as well as the impact of
loan sales. In contrast, average automobile leases increased $230 million, or 11%, reflecting the impact of 2004 originations
carrying over into 2005, as average new automobile lease production declined 47% from the prior year. Intense competition,
especially on pricing, drove the decline in automobile loan and lease production. Average commercial loans declined 6%,
reflecting a decline in middle market C&I floor plan loans, as well as a decline in middle market CRE loans to dealers.
The $138.3 million decrease in non-interest expense reflected a $131.2 million decline in operating lease expense, as well as an
8% decline in both personnel and other expenses.
The decline in the provision for credit losses reflected Dealer Sales’ continued focus on originating high quality assets in recent
years, as net charge-offs were 0.48% of average total loans and leases, down from 0.74% in 2004.
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