Huntington National Bank 2003 Annual Report Download - page 47

MANAGEMENT’S DISCUSSION AND ANALYSIS
also declined, reflecting the same prepayments and repayments of mortgage-related securities, with resultant reinvestment at lower
market rates. Rates on deposits and other interest-bearing liabilities declined as well, but less than the declines on loans and the
securities portfolio, reflecting competitive pressures in the deposit markets.
Two other factors contributing to a lower net interest margin were the growth of lower yielding investment securities and the shift to
lower yielding but lower-risk loans. The investment portfolio increased 29% during the year, reflecting redeployment of some of the
proceeds from automobile loan sales and the securitization and retention of residential mortgages originated in the mortgage banking
business. The improved credit quality of automobile loan and lease originations and the growth in the residential mortgage portfolio
resulted in a more risk-averse loan portfolio, with lower expected credit losses, though the portfolio will have a lower net interest margin.
Most of the year’s margin decline occurred during the first half of the year, with more modest declines in the third and fourth quarters
as interest rates rose slightly in the second half of the year. Specifically, the net interest margin in the 2003 first quarter was 3.63%,
3.47% in the second quarter, 3.46% in the third quarter, and 3.42% in the fourth quarter.
2002 versus 2001 Performance
Fully taxable equivalent net interest income was $754.8 million in 2002, up $33.2 million, or 5%, from 2001. This reflected a 33 basis point,
or an effective 10%, increase in the net interest margin to 3.62% from 3.29%, partially offset by a 5% decline in average earning assets.
The 33 basis point increase in the net interest margin was influenced by two factors. The first was the timing and magnitude of
declining interest rates in 2001 and 2002. As interest rates declined in the second half of 2001, deposit and wholesale funding costs
declined more rapidly than yields on earning assets, most notably loans and leases. As a result, the net interest margin widened in the
second half of 2001. However, as rates continued to decline in 2002, especially in the second half, and given the absolute low levels
attained, it became increasingly difficult to lower deposit funding costs commensurate with the decline in earning asset yields. As a
result, yields on earning assets fell more rapidly than deposit costs, thus narrowing the net interest margin in the second half of 2002,
particularly in the fourth quarter.
The second factor was a decision early in 2001 to reduce the level of low-return investment securities. This helped drive the increase in
the net interest margin during the first three quarters of 2001. Since the 2001 fourth quarter, consumer loan and lease production
shifted to higher credit quality automobile loan and lease production. This change in the loan and lease mix to lower-yield, but higher-
credit quality loans and leases mitigated the increase in the net interest margin. Also mitigating the net interest margin increase was the
significant growth in lower-yield residential mortgages. While this contributed to a reduced net interest spread on these assets, it
improved the total risk adjusted return as lower net charge-offs should be experienced in future periods. Reflecting these factors, the
net interest margin in the 2001 first quarter was 3.19% and increased steadily throughout the year, peaking at 3.46% in the fourth
quarter. During 2002, the margin peaked at 3.70% in the second quarter and declined to 3.62% in the fourth quarter.
The decline in average earning assets reflected a 4% decline in average loans and leases primarily due to the sale of the Florida banking
operations, as well as the planned run-off of lower-margin investment securities and other earning assets (see Table 4 and Balance
Sheet discussion).
B
ALANCE S HEET
L OAN AND L EASE P ORTFOLIO M IX
Table 6 shows total loans and leases were $21.1 billion at December 31, 2003, with 45% representing C&I and CRE loans and 55%
consumer loans and leases.
The relative decline of C&I and CRE loans over the last three years reflected a combination of factors including the objective to reduce
exposure to large individual credits, as well as to focus commercial lending to customers with existing or potential relationships within
the company’s primary markets. Reflecting this strategy, shared national credit outstandings declined to $704 million at December 31,
2003, down from $979 million at December 31, 2002, and from $1.1 billion at the end of 2001. The 2003 year-end outstandings were
down 52% from the $1.5 billion peak at June 30, 2001. In addition, there was weak demand for C&I loans, reflecting the weakness of
the economy.
On the consumer side, lower-rate, higher-quality residential mortgages represented 12% of total loans and leases (excluding operating
lease assets) at the end of last year, up from 9% a year earlier. Automobile loans and leases accounted for 23% of total loans and leases
(excluding operating lease assets) at December 31, 2003, up from 21% at the end of the prior year. Over the 2001-2003 period, the
HUNTINGTON BANCSHARES INCORPORATED 45