Huntington National Bank 2005 Annual Report Download - page 64

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MANAGEMENT’S DISCUSSION AND ANALYSIS HUNTINGTON BANCSHARES INCORPORATED
embedded options, such as borrowers’ ability to prepay residential mortgage loans at any time and depositors’ ability to terminate
CDs before maturity.
Our board of directors establishes broad policies with respect to interest rate risk. The Market Risk Committee (MRC) establishes
specific operating guidelines within the parameters of the board of directors’ policies. In general, we seek to minimize the impact
of changing interest rates on net interest income and the economic values of assets and liabilities. Our MRC regularly monitors
the level of interest rate risk sensitivity to ensure compliance with board of directors approved risk limits.
Interest rate risk management is a dynamic process that encompasses monitoring loan and deposit flows, investment and funding
activities, and assessing the impact of the changing market and business environments. Effective management of interest rate risk
begins with understanding the interest rate characteristics of assets and liabilities and determining the appropriate interest rate
risk posture given market expectations and policy objectives and constraints.
Interest rate risk modeling is performed monthly. Two broad approaches to modeling interest rate risk are employed: income
simulation and economic value analysis. An income simulation analysis is used to measure the sensitivity of forecasted net
interest income to changes in market rates over a one-year time horizon. Although bank owned life insurance and automobile
operating lease assets are classified as non-interest earning assets, and the income from these assets is in non-interest income,
these portfolios are included in the interest sensitivity analysis because both have attributes similar to fixed-rate interest earning
assets. The economic value of equity (EVE) is calculated by subjecting the period-end balance sheet to changes in interest rates,
and measuring the impact of the changes on the values of the assets and liabilities. EVE serves as a complement to income
simulation modeling as it provides risk exposure estimates for time periods beyond the one-year simulation horizon. Similar to
income simulation modeling, EVE analysis also includes the risks of bank owned life insurance and the mortgage servicing asset.
The models used for these measurements take into account prepayment speeds on mortgage loans, mortgage-backed securities,
and consumer installment loans, as well as cash flows of other loans and deposits. Balance sheet growth assumptions are also
considered in the income simulation model. The models include the effects of derivatives, such as interest rate swaps, interest rate
caps, floors, and other types of interest rate options, and account for changes in relationships among interest rates (basis risk).
The baseline scenario for income simulation analysis, with which all other scenarios are compared, is based on market interest
rates implied by the prevailing yield curve as of the period end. Alternative interest rate scenarios are then compared with the
baseline scenario. These alternative market rate scenarios include parallel rate shifts on both a gradual and immediate basis,
movements in rates that alter the shape of the yield curve (i.e., flatter or steeper yield curve), and spot rates remaining
unchanged for the entire measurement period. Scenarios are also developed to measure basis risk, such as the impact of LIBOR-
based rates rising or falling faster than the prime rate.
The simulations for evaluating short-term interest rate risk exposure are scenarios that model gradual 100 and 200 basis point
increasing and decreasing parallel shifts in interest rates over the next 12-month period beyond the interest rate change implied
by the current yield curve. The table below shows the results of the scenarios as of December 31, 2005, and December 31, 2004.
All of the positions were well within the board of directors’ policy limits.
Table 20 — Net Interest Income at Risk
Net Interest Income at Risk (%)
Basis point change scenario –200 –100 +100 +200
Board policy limits –4.0% –2.0% –2.0% –4.0%
December 31, 2005 –1.3% –0.5% +0.1% +0.3%
December 31, 2004 –1.2% –0.5% +0.2% +0.2%
The primary simulations for EVE at risk assume an immediate and parallel increase in rates of +/– 100 and +/– 200 basis points
beyond any interest rate change implied by the current yield curve. The table below outlines the results compared with the
previous year-end and policy limits. All of the positions were well within the board of directors’ policy limits.
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