Huntington National Bank 2004 Annual Report Download - page 104

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS HUNTINGTON BANCSHARES INCORPORATED
Huntington uses the cost recovery method of accounting for cash received on non-performing loans and leases. Under this method,
cash receipts are applied entirely against principal until the loan or lease has been collected in full, after which time any additional
cash receipts are recognized as interest income. When, in management’s judgment, the borrower’s ability to make periodic interest
and principal payments resumes and collectibility is no longer in doubt, the loan or lease is returned to accrual status. When
interest accruals are suspended, accrued interest income is reversed with current year accruals charged to earnings and prior year
amounts generally charged off as a credit loss.
–S OLD L OANS — Loans that are sold are accounted for in accordance with Statement No. 140, Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities. For loan sales, an asset is also recorded for the servicing of the loans sold,
which is retained at the time of sale, based on the relative fair value of the servicing rights.
Gains and losses on the loans sold and servicing rights associated with loan sales are determined when the related loans are sold to
the trust or third party. Fair values of the servicing rights are based on the present value of expected future cash flows from
servicing the underlying loans, net of adequate compensation to service the loans. The present value of expected future cash flows is
determined using assumptions for market interest rates, ancillary fees, and prepayment rates. Management also uses these
assumptions to assess the servicing rights for impairment periodically. The servicing rights are recorded in other assets in the
consolidated balance sheets. Servicing revenues on mortgage and automobile loans, net of the amortization of servicing rights, are
included in mortgage banking income and other non-interest income, respectively.
–A LLOWANCE FOR L OAN AND L EASE L OSSES — The allowance for loan and lease losses (ALLL) reflects management’s judgment as to
the level considered appropriate to absorb probable inherent credit losses in the loan and lease portfolio. This judgment is based on
the size and current risk characteristics of the portfolio, a review of individual loans and leases, historical and anticipated loss
experience, and a review of individual relationships where applicable. External influences such as general economic conditions,
economic conditions in the relevant geographic areas and specific industries, regulatory guidelines, and other factors are also
assessed in determining the level of the allowance.
The allowance is determined subjectively, requiring significant estimates, including the timing and amounts of expected future cash
flows on impaired loans and leases, consideration of current economic conditions, and historical loss experience pertaining to pools
of homogeneous loans and leases, all of which may be susceptible to change. The allowance is increased through a provision that is
charged to earnings, based on Management’s quarterly evaluation of the factors previously mentioned, and is reduced by charge-
offs, net of recoveries, and the allowance associated with securitized or sold loans.
The ALLL consists of three components, the transaction reserve, specific reserve, and economic reserve. Loan and lease losses
related to transaction and specific reserves are recognized and measured pursuant to Statements No. 5, Accounting for Contingencies
and 114, while losses related to the economic reserve are recognized and measured pursuant to Statement No. 5. The three
components are more fully described below.
Transaction Reserve
The transaction reserve component represents an estimate of loss based on characteristics of each commercial and consumer
loan or lease in the portfolio. Each loan and lease is assigned a probability-of-default and a loss-in-event-of-default factor
that are used to calculate the transaction reserve.
For middle market commercial and industrial, middle market commercial real estate, and small business loans, the
calculation involves the use of a standardized loan grading system that is applied on an individual loan level and updated on
a continuous basis. The reserve factors applied to these portfolios were developed based on internal credit migration models
that track historical movements of loans between loan ratings over time and a combination of long-term average loss
experience of the Company’s own portfolio and external industry data.
In the case of more homogeneous portfolios, such as consumer loans and leases and residential mortgage loans, the
determination of the transaction component is conducted at an aggregate, or pooled, level. For such portfolios, the
development of the reserve factors includes the use of forecasting models to measure inherent loss in these portfolios.
Models and analyses are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well
as any changes in the loss mitigation or credit origination strategies. Adjustments to the reserve factors are made as needed
based on observed results of the portfolio analytics.
Specific Reserve
The specific reserve component is associated only with the middle market commercial and industrial, middle market
commercial real estate, and small business segments and is the result of credit-by-credit reserve decisions for individual
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