Huntington National Bank 2004 Annual Report Download - page 48

MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED
2004 versus 2003 Performance
Average operating lease assets in 2004 declined 47% from the prior year as these assets continued to run-off.
The net earnings contribution from operating leases was $50.6 million in 2004, down 48% from $96.4 million in 2003. While both
operating lease income and operating lease expense are expected to decline commensurate with the decline in operating lease assets,
operating lease income declined more rapidly than operating lease expense. This was because residual value losses have remained
elevated on a relative basis, partially due to the fact that losses have exceeded the cap on one of the residual value insurance policies.
Operating lease income, which totaled $287.1 million in 2004, and represented 35% of non-interest income, declined 41% from 2003
reflecting the decline in average operating leases. The majority of this decline was reflected in lower net rental income, down 42%
from 2003. Lower fees and recoveries from early terminations also contributed to the decline in total operating lease income, but to a
much lesser degree.
Operating lease expense totaled $236.5 million, down 40% from a year ago, also reflecting the continued decline in operating lease
assets, with the decline primarily related to lower depreciation and residual losses at termination expenses.
Losses on operating lease assets consist of residual losses at lease termination and losses on early terminations. Residual losses arise if
the ultimate value or sales proceeds from the automobile are less than Black Book value, which represents the insured amount under
the Company’s residual value insurance policies. This situation may occur due to the results of vehicle remarketing efforts, excess
wear-and-tear, excess mileage, or other market value fluctuations. Losses on early terminations occur when a lessee, due to credit or
other reasons, turns in the automobile before the end of the lease term. A loss is realized if the automobile is sold for a value less than
the net book value at the date of turn-in. Such losses are not covered by the residual value insurance policies. To the extent the
Company is successful in collecting any deficiency from the lessee, amounts received are recorded as recoveries from early
terminations.
On a quarterly basis, Management evaluates the amount of residual value losses that it anticipates will result from the estimated fair
value of a leased vehicle being less than the residual value inherent in the lease. Fair value includes estimated net proceeds from the
sale of the leased vehicle plus expected residual value insurance proceeds and amounts expected to be collected from the lessee for
excess mileage and other items that are billable under terms of the lease contract. When estimating the amount of expected insurance
proceeds, Management takes into consideration policy caps that exist in the residual value insurance policies covering the operating
lease assets and whether it expects aggregate claims under such policies to exceed these caps. Residual value losses exceeding any
insurance policy cap are reflected in higher depreciation expense over the remaining life of the affected automobile lease. Also as part
of its quarterly analysis, Management evaluates automobile leases individually for impairment.
Residual value losses on automobile leases booked prior to October 1, 2000, are covered by an insurance policy with a $120 million
cap. During the 2004 third quarter, residual value losses exceeded this cap, resulting in higher operating lease depreciation expense.
Total losses above the cap are expected to be $17-$28 million, including $10 million already recognized and reflected in additional
accumulated depreciation. The residual value insurance policy covering automobile leases originated between October 1, 2000 and
April 30, 2002 contains a $50 million cap. At this time, the Company anticipates that total claims against this policy will be $11-
$25 million, well below its cap. To date, approximately $5 million of claims have been filed on this policy.
Credit losses on operating lease assets are included in operating lease expense and were $20.0 million in 2004, down from
$42.7 million a year earlier. Recoveries on operating lease assets are included in operating lease income and totaled $6.4 million in
2004, down from $9.4 million a year earlier. The ratio of operating lease asset credit losses to average operating lease assets, net of
recoveries, was 1.52% in 2004, down from 1.96% in 2003.
2003 versus 2002 Performance
Average operating lease assets in 2003 declined 35% from 2002. The net earnings contribution from operating leases was $96.4 million
in 2003, down from $138.1 million in 2002, a 30% decline. Operating lease income declined $167.4 million, or 25%, from 2002.
Operating lease expense declined $125.7 million, or 24%, from the prior year.
The ratio of operating lease asset credit losses to average operating lease assets, net of recoveries, was 1.96% in 2003, up from 1.62%
in 2002.
Provision for Income Taxes
The provision for income taxes was $153.7 million in 2004, $138.3 million in 2003 and $199.0 million in 2002. The effective tax rate
was 27.8%, 26.4% and 38.1% in 2004, 2003 and 2002, respectively. The higher effective tax rate in 2004 compared with 2003 reflected
a reduction in tax benefits (credits) from investments in partnerships and the impact of non-deductible expenses. Tax expense in 2002
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