Huntington National Bank 2003 Annual Report Download - page 63

MANAGEMENT’S DISCUSSION AND ANALYSIS
to benefit from a future flattening of the yield curve, including the purchase of intermediate maturity securities, hedged with shorter-
term maturity interest rate swaps, and (3) the use of ten-year investment securities to offset the interest rate risk of the growing MSR
portfolio.
L EASE R ESIDUAL R ISK
Lease residual risk associated with retail automobile and commercial equipment leases is the potential for declines in the fair market
value of the vehicle or equipment below the maturity value estimated at origination. Most of Huntington’s lease residual risk is in its
automobile leases. Used car values are the primary factor in determining the magnitude of the risk exposure. Since used car values are
subject to many factors, residual risk has been extremely volatile throughout the history of automobile leasing. Management mitigates
lease residual risk by purchasing residual value insurance. Residual value insurance provides for the recovery of the vehicle residual
value as specified by the Automotive Lease Guide (ALG), an authoritative industry source, at the inception of the lease. As a result, the
risk associated with market driven declines in used car values is mitigated. Currently, three distinct residual value insurance policies are
in place to address the residual risk in the portfolio. As indicated in Significant Factor item 8, two residual value insurance policies
cover all vehicles leased prior to May 2002, and have associated total payment caps of $120 million and $50 million, respectively.
Management reviews expected future residual value losses to determine the need to either (a) establish a reserve for losses in excess of
both insurance policy caps or (b) reduce the expected residual value and, therefore, increase the rate of depreciation. At December 31,
2003, the lease residual reserve was $2.1 million. A third policy, which covers vehicles leased since April 2002, provides similar coverage
as the first two, but has no cap on losses payable. The Risk Management group monitors the lease residual risk on an on-going basis.
P
RICE R ISK
Price risk represents the risk of loss from adverse movements in the non-interest related price of financing instruments that are carried
at fair value. The risk of loss from adverse movements in interest-related prices is interest rate risk. Price risk is a less significant market
risk for Huntington. Price risk is incurred in the trading securities held by broker-dealer subsidiaries, in the foreign exchange positions
that the Bank holds held to accommodate its customers, in investment’s in limited partnerships, and in the marketable equity securities
available for sale held by insurance subsidiaries. To manage price risk, Management establishes limits as to the amount of trading
securities that can be purchased, the foreign exchange exposure that can be maintained, and the amount of marketable equity securities
that can be held by the insurance subsidiary.
Liquidity
The objective of effective liquidity management is to ensure that cash flow needs can be met on a timely basis at a reasonable cost
under both normal operating conditions and unforeseen or unpredictable circumstances. The liquidity of the Bank is used to originate
loans and leases and to repay deposit and other liabilities as they become due or are demanded by customers. Liquidity risk arises from
the possibility that funds may not be available to satisfy current or future commitments based on external macro market issues,
investor perception of financial strength, and events unrelated to the company such as war, terrorism, or financial institution market
specific issues.
Liquidity policies and limits are established by the board of directors, with operating limits set by ALCO, based upon analyses of the
ratio of loans to deposits and percentage of assets funded with non-core or wholesale funding. In addition, guidelines are established to
ensure diversification of wholesale funding by type, source, and maturity and provide sufficient balance sheet liquidity to cover 100%
of wholesale funds maturing within a six-month time period. A contingency funding plan is in place, which includes forecasted sources
and uses of funds under various scenarios in order to prepare for unexpected liquidity shortages, including the implications of any
rating changes. ALCO meets monthly to identify and monitor liquidity issues, provide policy guidance, and oversee adherence to, and
the maintenance of, an evolving contingency funding plan.
Credit ratings by the three major credit rating agencies are an important component of the company’s liquidity profile. Among other
factors, the credit ratings are based on the financial strength, credit quality and concentrations in the loan portfolio, the level and
volatility of earnings, capital adequacy, the quality of management, the liquidity of the balance sheet, the availability of a significant
base of core retail and commercial deposits, and the company’s ability to access a broad array of wholesale funding sources. Adverse
changes in these factors could result in a negative change in credit ratings and impact not only the ability to raise funds in the capital
markets, but also the cost of these funds. In addition, certain financial on- and off-balance sheet arrangements contain credit rating
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