Huntington National Bank 2003 Annual Report Download - page 78

MANAGEMENT’S DISCUSSION AND ANALYSIS
D EALER S ALES
Dealer Sales serves over 3,500 automotive dealerships within Huntington’s primary banking markets as well as in Arizona, Florida,
Georgia, Pennsylvania, and Tennessee. The segment finances the purchase of automobiles by customers of the automotive dealerships,
purchases automobiles from dealers and simultaneously leases the automobiles under long-term direct finance leases, provides
financing for dealership floor plan inventories, real estate, or working capital needs, and provides other banking services to the
automotive dealerships and their owners.
The accounting for automobile leases significantly impacts the presentation of Dealer Sales’ financial results. All 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. For automobile leases originated prior to May 2002, the related financial results are reported as operating lease income
and operating lease expense, components of non-interest income and non-interest expense, respectively, whereas the cost of funding
such leases is included in interest expense. As a result of the treatment of operating leases, the net interest margin increased from 2001
to 2002 as the declining operating lease portfolio resulted in less assessed interest expense. Credit losses associated with these leases are
also reflected in operating lease expense. With no new operating leases being originated, this portfolio, and related operating lease
income and operating lease expense, will decrease over time and eventually become immaterial. In contrast, all new leases since April
2002 are originated as direct financing leases, where the income and funding are included in net interest income. Direct financing lease
credit losses are charged against an allowance for loan and lease losses with provision expense recorded to maintain an appropriate
allowance level.
2003 versus 2002 Performance
Dealer Sales contributed $60.0 million of the company’s net operating earnings in 2003, up from $23.9 million in 2002. Higher
bankruptcies and a softer used car market continued to have adverse impacts on the operating performance of this segment. These
factors generally stabilized or improved in 2003.
Also, as previously noted, in May 2002, Dealer Sales began recording all automobile leases as direct financing leases instead of operating
leases. Thus, as the operating lease portfolio runs-off and the direct financing portfolio grows, the various related income and expense
categories are impacted accordingly.
Net interest income was $107.2 million for 2003, compared with $5.3 million for 2002. This very significant increase reflected a 45%
increase in total loans and leases, as well as a higher net interest margin.
Average automobile loans increased 21% reflecting strong originations and the consolidation of previously securitized loans, partially
offset by loan sales. During 2003, $2.8 billion of automobile loans were originated, up 19% from 2002. This increase occurred despite
relatively flat growth in industry-wide new and used vehicle sales in 2003 compared with 2002, as Dealer Sales continued to increase
market share in nearly all of its markets. Also, higher production levels in recently entered or expanded markets (Arizona, Tennessee,
Georgia, Northern Indiana, and Central and Southeast Florida) contributed to the increase. The growth in average automobile loans
also reflected the July 1, 2003, consolidation of $1.0 billion of previously securitized automobile loans related to the adoption of FIN
46. Partially offsetting these two factors, was a $0.5 billion average impact of the sale of $2.1 billion of automobile loans reflecting
efforts to lower the overall credit risk exposure to automobile financing (see Significant Factors item 8).
Average automobile direct financing leases increased $1.0 billion and reflected $1.3 billion of automobile direct financing lease
originations, up 12% from 2002. The very large increase in average direct financing leases from 2002 reflected the fact that this is a
young portfolio and consists only of leases originated since April 2002. This growth contrasts with the $0.9 billion reduction in average
operating lease assets, a more mature lease portfolio, as it consists of all automobile leases originated prior to May 2002.
Also contributing to the growth in total loans and leases was a 22% increase in average C&I loans, including dealer floor plan loans.
The net interest margin was also favorably impacted by the run-off of the operating lease assets due to the fact that all of the funding
cost associated with these assets is reflected in interest expense, whereas the income is reflected in non-interest income.
The provision for loan and lease losses increased 28%, reflecting growth in loans and direct financing leases and, to a lesser degree, a
$5.1 million increase in net charge-offs. Net charge-offs for Dealer Sales are concentrated in automobile loans and leases. The net
charge-off ratio for automobile loans was 1.24% in 2003, down from 1.37% in 2002, and reflected the continued upward trend in the
credit quality of loans originated. Charge-offs of direct financing leases in 2003 represented 0.40% of average balances outstanding, up
76 HUNTINGTON BANCSHARES INCORPORATED