Huntington National Bank 2004 Annual Report Download - page 59

MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED
Economic Value of Equity at Risk (%)
Basis point change scenario –200 –100 +100 +200
Board Policy Limits –12.0% –5.0% –5.0% –12.0%
December 31, 2004 –3.0% –0.5% –1.5% –4.0%
December 31, 2003 N.M. +1.8% –3.5% –7.9%
N.M., not a meaningful value.
Lease Residual Risk
(This section should be read in conjunction with Significant Factor 1 and the Operating Lease Assets section.)
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, lease 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 a decline in
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. 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. During the 2004 third
quarter, the $120 million cap was exceeded on the first policy, and it is Management’s assessment that the $50 million cap remains
sufficient to cover any expected losses. A third residual insurance policy covers all originations from May 2002 through April 2005.
This policy does not have a cap and Huntington is actively engaged in negotiations to extend this policy.
Price Risk
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. Price risk is incurred in the trading securities held by broker-dealer subsidiaries, in the foreign exchange positions that
the Bank holds to accommodate its customers, in investments in private equity limited partnerships accounted for at fair value, 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 Risk
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 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, asset and liability
activities, 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 MRC, based upon analyses of the
ratio of loans to deposits and the 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. MRC 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 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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