Huntington National Bank 2005 Annual Report Download - page 39

MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED
Partially offset by:
– $250.6 million, or 23%, decline in non-interest income. Contributing to the decrease were a $202.6 million decline in
operating lease income, a $25.9 million decline in mortgage banking income, a $25.8 million decline in gains on sales of
automobile loans, and the fact that 2003 benefited from a $13.1 million gain on sale of branch offices. Partially offsetting
these declines were $10.5 million of higher securities gains, a $5.8 million increase in trust income, and a $3.3 million
increase in service charges on deposits.
– $15.4 million increase in income tax expense as the effective tax rate for 2004 was 27.8%, up from 26.4% in 2003.
The ROA and ROE for 2004 were 1.27% and 16.8%, respectively, down from 1.29% and 17.0%, respectively, in 2003.
Results Of Operations
Significant Factors Influencing Financial Performance Comparisons
Earnings comparisons from 2003 through 2005 were impacted by a number of factors, some related to changes in the economic
and competitive environment, while others reflected specific management strategies or changes in accounting practices. Those key
factors are summarized below.
1. A
UTOMOBILE LEASES ORIGINATED THROUGH A PRIL 2002 ARE ACCOUNTED FOR AS OPERATING LEASES .— Automobile leases
originated before May 2002 are accounted for using the operating lease method of accounting because they do not
qualify as direct financing leases. Operating leases are carried in other assets with the related rental income, other
revenue, and credit recoveries reflected as operating lease income, a component of non-interest income. Under this
accounting method, depreciation expenses, as well as other costs and charge-offs, are reflected as operating lease expense,
a component of non-interest expense. With no new operating leases originated since April 2002, the operating lease
assets have declined rapidly. It is anticipated that the level of operating lease assets and related operating lease income
and expense will decline to a point of diminished materiality sometime in 2006. However, until that point is reached,
and since operating lease income and expense represented a significant percentage of total non-interest income and
expense, respectively, throughout these reporting periods, their downward trend influenced total revenue, total non-
interest income, and total non-interest expense trends.
In contrast, automobile leases originated since April 2002 are accounted for as direct financing leases, an interest earning
asset included in total loans and leases with the related income reflected as interest income and included in the
calculation of the net interest margin. Credit charge-offs and recoveries are reflected in the ALLL, with related changes
in the ALLL reflected in the provision for credit losses. The relative newness and rapid growth of the direct financing
lease portfolio resulted in higher reported automobile lease growth rates than in a more mature portfolio, especially in
2002 through 2004. To better understand overall trends in automobile lease exposure, it is helpful to compare trends in
the combined total of direct financing leases plus operating leases.
2. M ORTGAGE SERVICING RIGHTS (MSR S ) AND RELATED HEDGING .— Interest rate levels throughout this period have
remained low by historical standards, though they have generally been rising in 2004 and 2005. They have also been
volatile, with increases in one quarter followed by declines in another and vice versa. This has impacted the valuation of
MSRs, which can be volatile when rates change.
– Since the second quarter of 2002, we have generally retained the servicing on mortgage loans we originate and sell.
MSR values are very sensitive to movements in interest rates as expected future net servicing income depends on
the projected outstanding principal balances of the underlying loans, which can be greatly reduced by prepayments.
Prepayments usually increase when mortgage interest rates decline and decrease when mortgage interest rates rise.
Thus, as interest rates decline, less future income is expected and the value of MSRs declines. We recognize
impairment when the valuation is less than the recorded book value. We recognize temporary impairment due to
changes in interest rates through a valuation reserve and record a direct write-down of the book value of MSRs for
other-than-temporary declines in valuation. Changes and fluctuations in interest rate levels between quarters
resulted in some quarters reporting an MSR temporary impairment, with others reporting a recovery of previously
recognized MSR temporary impairment. Such swings in MSR valuations have significantly impacted quarterly
mortgage banking income trends throughout this period.
– Prior to 2004, we used investment securities as the primary method of offsetting MSR temporary valuation changes.
Beginning in 2004, we have used trading account assets. The valuations of trading and investment securities
generally react to interest rate changes in an opposite direction compared with changes in MSR valuations. As a
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