Huntington National Bank 2003 Annual Report Download - page 70

MANAGEMENT’S DISCUSSION AND ANALYSIS
At December 31, 2003, the tangible common equity ratio was 6.80%, down from 7.22% at the end of 2002. The decline was a function
of (1) $81.1 million related to the repurchase of the company’s stock in the 2003 first quarter, (2) $1.0 billion of securitized loans
consolidated onto the balance sheet in the 2003 third quarter due to the adoption of FIN 46, and (3) $2.0 billion of tangible asset
growth. Management has targeted a longer-term tangible common equity to asset ratio of 6.50%-6.75%, given the current portfolio
risk profile.
Another measure of capital adequacy favored by one of the rating agencies is tangible common equity to risk-weighted assets. This
measurement utilizes risk-weighted assets, as defined in the regulatory capital ratio. Unlike the tangible common equity ratio, which
declined 42 basis points during the year, this ratio increased slightly to 7.30% at the end of 2003 from 7.29% at the end of 2002. The
ratio (1) was favorably impacted by the addition of lower risk-weighted assets during the year, i.e., residential mortgages, home equity
loans, and investment securities, and (2) was not adversely impacted by the consolidation of the $1.0 billion of securitized loans as they
have always been a component of risk-weighted assets.
E
CONOMIC C APITAL
Huntington makes asset allocation and balance sheet management decisions in the context of capital management primarily based on
an economic capital model. All products are allocated equity based on a determination of credit, market, and operational risk levels. All
commercial credit extensions are evaluated using a return on risk-adjusted capital (RORAC) model that considers pricing, internal risk
rating, structure, tenor, and deposit relationship among other variables. The consumer lending portfolios are also evaluated on a
RORAC basis. The non-credit related products are evaluated based on the return on capital held for operational and/or market risk.
Although the level of capital is generally lower for these products, the return calculation and assessment process is the same. This allows
for a quantitative basis for balance sheet management decisions.
Lines of Business Discussion
Huntington has three distinct lines of business: Regional Banking, Dealer Sales, and the Private Financial Group (PFG). A fourth
segment includes the company’s Treasury function and other unallocated assets, liabilities, revenue, and expense. Line of business
results are determined based upon the company’s management reporting system, which assigns balance sheet and income statement
items to each of the business segments. An overview of this system is provided below, along with a description of each segment and
discussion of financial results.
F
UNDS T RANSFER P RICING
The company uses a centralized funds transfer pricing (FTP) methodology to attribute appropriate net interest income to the business
segments. The Treasury/Other business segment charges (credits) an internal cost of funds for assets held in (or pays for funding
provided by) each line of business. The FTP rate is based on prevailing market interest rates for comparable duration assets (or
liabilities). Deposits of an indeterminate maturity receive an FTP credit based on a vintage-based pool rate. Other assets, liabilities, and
capital are charged (credited) with a four-year moving average FTP rate. The intent of the FTP methodology is to eliminate all interest
rate risk from the lines of business by providing matched duration funding of assets and liabilities. The result is to centralize the
financial impact of interest rate and liquidity risk for the company in Treasury/Other.
The FTP methodology also provides for a charge (credit) to the line of business when a fixed-rate loan is sold and the internal funding
associated with the loan is extinguished. The charge (credit) to the line of business represents the cost (or benefit) to Treasury/Other of
the early extinguishment of the internal fixed-rate funding. This charge (credit) has no impact on consolidated financial results.
Beginning January 1, 2002, significant changes were made to the FTP methodology in order to more accurately reflect product margins
and profitability. These changes materially impact the comparability between the 2003 and 2002 periods compared with 2001. These
changes included charging a liquidity premium for loans having a commitment term greater than their re-pricing period.
A
LLOCATION OF THE ALLL
Beginning January 1, 2003, changes were also made in the methodology of allocating the ALLL to loan balances within each business
segment. Prior to 2003, the company maintained an unallocated component of its ALLL, as did many banks. The unallocated
component was eliminated in 2003 with the adoption of the more granular risk rating system with most of the prior unallocated
reserve absorbed into the transaction reserve. With the adoption of the new risk grading system, Management has determined that an
unallocated component is no longer necessary.
68 HUNTINGTON BANCSHARES INCORPORATED