Huntington National Bank 2003 Annual Report Download - page 135

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following methods and assumptions were used by Huntington to estimate the fair value of the remaining classes of financial
instruments:
Mortgages held for sale—valued using outstanding commitments from investors.
Securities available for sale and investment 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.
Loans and 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.
Deposits—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.
Debt—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.
28. 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 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, but with a comparable level of net interest revenue and return
on equity. All derivatives are reflected at fair value in the consolidated balance sheet. Huntington also uses derivatives, principally loan
sale commitments, in the hedging of its mortgage loan commitments and its mortgage loans held for sale.
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 also 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 in 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 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 ineffective, it no longer qualifies as a hedge and
any excess gains or losses attributable to ineffectiveness, as well as subsequent changes in fair value, are recognized in other income.
For fair value hedges, specified fixed-rate automobile loans, 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 its mortgage banking activities, settle in cash at a specified future date based on the differential between agreed interest
HUNTINGTON BANCSHARES INCORPORATED 133