Huntington Bancshares Inc (HBAN) — Q1 2018 Earnings Call Transcript

Thank you, Melissa. Welcome. I’m Mark Muth, Director of Investor Relations for Huntington. Copies of the slides we will be reviewing can be found on the Investor Relations section of our website, www.huntington.com. This call is being recorded and will be available as a rebroadcast starting about one hour from the close of the call. Our presenters today are Steve Steinour, Chairman, President and CEO, and Mac McCullough, Chief Financial Officer. Dan Neumeyer, our Chief Credit Officer, will also be participating in the Q&A portion of today’s call. As noted on Slide 2, today’s discussion, including the Q&A period, will contain forward-looking statements. Such statements are based on information and assumptions available at this time and are subject to changes, risks, and uncertainties, which may cause actual results to differ materially. We assume no obligation to update such statements. For a complete discussion of risks and uncertainties, please refer to the slides and materials filed with the SEC, including our most recent Forms 10-K, 10-Q, and 8-K filings. Now I’m turning it over to Steve.

Thanks Mark. And thank you to everyone for joining the call today. As always, we appreciate your interest and support. We had a solid first quarter and entered 2018 with momentum. We reported net income of $326 million and earnings per share of $0.28, up 65% from the year-ago quarter. Return on common equity was 13% and return on tangible common equity was 17.5%. Average loans increased 9% annualized versus the fourth quarter 2017, driven by disciplined broad-based growth in both commercial and consumer loans. We’re pleased with our first quarter efficiency ratio of 57%, driven by 3% year-over-year revenue growth and expense discipline. The franchise continues to perform well on many fronts as a result of focused execution and the realized economics of the FirstMerit deal. As previously outlined on Slide 3, we developed Huntington strategies with a vision of creating a high performing regional bank and delivering top quartile through-the-cycle shareholder returns. We prudently allocate our capital to ensure we’re earning adequate returns and taking appropriate risk. We also continued to make meaningful long-term investments in our businesses, particularly around customer experience to drive organic growth. We’re very pleased with how we're positioned with the sustainable competitive advantages we've created. And Slide 4 illustrates our long-term financial goals, which were approved by the Board in the fall of 2014 as part of our strategic planning process. These goals were originally set with a five-year time horizon in mind and we fully expect to achieve these goals this year on both a reported GAAP basis and an adjusted non-GAAP basis. Now our first quarter efficiency ratio was near the low end of our long-term goal as a result of the successful integration of FirstMerit, our expense discipline, and focus on revenue growth. Charge-offs remain below our long-term expectation. Our 17.5% return on tangible common equity positions Huntington as a top performing regional bank. And these peer-leading results demonstrate that our strategies are working and will continue to drive Huntington forward. We're pleased with our first quarter performance against all of these metrics. Also, I’d like to take this opportunity to remind you of the considerable improvement in our financial performance since 2014 when we introduced these goals. So in the first quarter of 2014, our return on tangible common equity was 11.3% and our efficiency ratio was 66.4%. So through our disciplined execution over the years, we’ve elevated Huntington from the middle of the peer group to peer-leading financial performance, driving a greater than 600 basis point improvement in ROTCE and almost 1,000 basis point improvement in the efficiency ratio alone. Let's now turn to Slide 5 to review 2018 expectations and discuss the current economic and competitive environment in our markets. We remain optimistic on the outlook for the local economies across our eight-state footprint. And as we've noted previously, our footprint has outperformed the rest of the nation during the economic recovery that began in mid-2009. Unemployment rates across the majority of our footprint remain near historical lows. The labor market in our footprint has proven to be strong with several markets such as Columbus, Indianapolis, and Grand Rapids, where we see meaningful labor shortages given metro unemployment rates, which are well below national averages. The Philadelphia Fed’s state leading indicator indices for our footprint point toward a favorable economic operating environment in 2018; most of the states are expected to see an acceleration in economic activity over the next six months. Four of our states, including Ohio, are expected to grow significantly faster than the nation as a whole. As a result of federal tax reform, we expect continued business investment and expansion. We are seeing an increased capital expenditure. It's important to remember that our commercial focus is primarily on privately held businesses and these companies are likely to reinvest tax benefits into their businesses to fund growth. As noted in Site Selection Magazine’s Governor’s Cup for Capital Investments and New Jobs created in 2017, five of our eight states placed in the top 10 of the nations for total qualified new projects, with Ohio earning the number two spot overall. These rankings and leading indicators confirm our optimism. But importantly, our loan pipelines remain solid across all footprints. And as I get out and talk to different business owners, I can confirm there is a widespread level of optimism. In fact, if anything we’re being held back by labor supply shortages. We’re clearly seeing impacts in construction and other businesses where they just can't get enough labor. And as a consequence, we’re starting to see labor inflation, but we’re also seeing businesses now that are working on next year's pipelines of activity. So backlogs are looking good in many of our businesses, manufacturing and construction being two examples. And we’re feeling very good on the whole about this year and stressing into next. And so while the growth trends will likely not be linear, we remain optimistic with our full year outlook. We expect full-year average loan growth in the range of 4% to 6% inclusive of a $500 million auto loan securitization in the back half of the year. Full-year average deposit growth is expected to be 3% to 5%, and for internal forecasts and guidance purposes, we continue to assume no additional interest rate changes consistent with our approach over the last few years. And while it appears likely that the Fed might act again this year, it has served us well to take a more conservative approach in our forecasting process. We expect full-year revenue growth of 4% to 6%. We are projecting the GAAP NIM for the full year to be flat and the core NIM to be up modestly in 2018. On the expense side, we are expecting a 2% to 4% decrease from the 2017 GAAP non-interest expense of $2.7 billion. Our expectations include improvement in the efficiency ratio to a range of 55% to 57%, as well as we are targeting positive operating leverage for the sixth consecutive year. We anticipate net charge-offs will remain below our long-term goal of 35 to 55 basis points. Importantly, we’ve lowered our expectation for the effective tax rate to the 15.5% to 16.5% range. The range is fully reflective of federal tax reform. Now looking beyond 2018, we recently began a new three-year strategic planning process. Our pass-through strategic plan significantly advances the Company's financial performance and competitive positioning. To continue this momentum, our initial areas of focus for the 2018 strategic planning process are number one; top-line revenue growth; two, capital optimization; and three, business model evolution incorporating expected disruption. As we stated previously, an important outcome of the strategic planning process will be new long-term financial goals for the Company, and we expect to be in a position to communicate those later in the year.

Thanks Steve. Slide 6 provides the highlights of the first quarter. As Steve mentioned, we had a good first quarter, but also a clean quarter as there were no significant items. We reported earnings per common share of $0.28 for the first quarter, up 65% over the year-ago quarter. The year-ago quarter included a $0.04 per share reduction due to significant items related to the FirstMerit integration. Return on assets was 1.27%, return on common equity was 13%, and return on tangible common equity was 17.5%. We believe all three of these metrics distinguish Huntington among our regional bank peers. Our efficiency ratio for the quarter was 56.8%. Tangible book value per share increased 2% sequentially and 9% year-over-year. During the first quarter, we repurchased $48 million of common stock, representing 3 million shares at an average cost of $15.83 per share. This completed the $308 million buyback authorization under a 2017 CCAR plan. Turning to Slide 7, total revenue was up 3% from the year-ago quarter. Net interest income was up 5% year-over-year due to a 5% increase in average earning assets while the net interest margin was unchanged. Non-interest income increased 1% year-over-year with increases in capital market fees, card and payment processing revenue, and trust and investment management fees, partially offset by lower mortgage banking income and a reduction in gains on the sale of loans, primarily related to the sale of an equipment finance loan in the year-ago quarter. While both mortgage and SBA originations were higher year-over-year, compression in secondary market spreads in mortgage banking and the timing of SBA loans sales resulted in year-over-year declines in these fee categories. FirstMerit-related revenue enhancement opportunities remain on track to deliver over $100 million of revenue in 2018 with an efficiency ratio below 50%. As we stated before, these projections are included in our 2018 guidance. Non-interest expense decreased 10% year-over-year due entirely to $73 million of significant items expensed in the year-ago quarter related to the integration of FirstMerit versus no significant items expensed in the current quarter. Expenses were flat versus the prior quarter. It should be noted that expenses are historically higher in the second quarter, primarily driven by the timing of compensation associated with long-term incentives and seasonally higher marketing expenses, which combined could add up to $20 million compared to the first quarter. However, these are just timing differences, and as Steve mentioned earlier, we remain comfortable with full-year guidance, including full-year expectations for non-interest expenses per analyst estimates.

We will now take questions. We ask that as a courtesy to your peers, each person ask only one question and one related follow-up. And then if that person has additional questions, he or she can add themselves back into the queue. Thank you.

First question, Steve maybe for you, I just wanted to talk about the outlook that you guys have always been extraordinarily conservative on the rate outlook. It looks like it’s going to come in more accommodative than is embedded in your outlook for no rate increases. So in a sense that difference ends up becoming kind of found money. So I guess if we were to get another hike or two, what is at a top level the plan? If you allow that similarly to drop to the bottom line or do you think about maybe reinvesting, accelerating some costs, maybe being even more aggressive on taking deposit market share, et cetera. What would be your thinking at the top level?

We budget, we plan for no rate increases, but we obviously run scenarios around it. Mac shared that with you, Scott, on the call in terms of deposit betas. We do think this environment is one that’s conducive to us growing organically in a meaningful way. Pleased with the first quarter and we closed with good pipelines as we come into the second quarter. So we would expect the organic growth to continue. And in that construct, we look to continue to grow both the deposit and loan side. We’re very focused on the fee side of the quarter and what we can do prospectively on that front as well. We had good SBA activity, for example, but we ended up seeing a lot more of a construction nature than we’ve had before. So it’s a sign of capital investment. There is a belief that by operating in this more conservative fashion, we’ll be a little more agile as we move forward with the benefit of rate increases. Anything you want to add, Mac?

Scott, the way to think about it is a 25 basis point increase in rates on an annual basis is about $25 million in margin on an annual basis. So that obviously says a lot of assumptions around what we're expecting from the deposit betas and competition in the marketplace. And of course, the lapping yield curve has not been conducive to that either. So we’re a little bit cautious as we move through this. We do think there will be opportunities from increasing rates, but at the same time, we’ve never focused on growing core deposits. We had great core deposit growth year-over-year at about 3%, and we aim to continue to do that.

And I guess what I was getting at is, let's say, you get some portion of the $25 million, you just let that drop straight to the bottom line and use that as an opportunity to maybe spend a little more than you would have anticipated? Just given the disconnect between how you’re likely to pan out in terms of rate moves versus what you guys are forecasting in the guidance?

Scott, we have significant investment built into the 2018 budget already. So clearly, we will be opportunistic as we think about what might happen from a rate increase perspective. And I would expect that the majority of that would drop to the bottom line, but we’ll selectively look at the investment opportunities on the digital front and in particular in customer experience and our colleagues.

And then just maybe one follow-up. What was it that led you guys to improve the tax rate guide just a little bit? I mean, I know it’s not huge, but just curious your thoughts.

What it really came down to, Scott, is we’d like to give you ranges that are meaningful in terms of actually being able to achieve and fall within the range. And the fact of the matter is 17% would just be fine. So that’s why we felt 15.5% to 16.5% was a better range for us to consider going forward.

This is actually Sam Ross on for John this morning. I just had a question about the ROTC guidance. I appreciate the fact you guys are currently reviewing your three-year plan. I am just wondering, given the fact where your 1Q ROTC came in, what do you guys think is an appropriate level for 2018 for you guys to operate in?

So I would expect to be in that range. I mean, we’re in the process of going through the long-term strategic plan. We’re going to come out later this year with our new expectations for all those metrics. It's really important to keep in mind that we're going to operate within an aggregate moderate to low risk appetite, and a 17.5% ROTCE with an aggregate moderate to low risk appetite is pretty good in our estimation. So I wouldn’t expect that you're going to see significant change within that goal going forward, but we’ll go through the strategic planning process and we’ll let you know later this year.

And then just looking at the balance sheet. In terms of the non-interest bearing deposits, I know you guys touched upon it in your prepared remarks about a mix shift that you guys are seeing into more higher interest rate products. I am just wondering if there was anything outside of seasonality, you can maybe provide a little bit more color on if the sizeable decline in non-interest bearing deposits. I think that would be helpful. Thanks.

I think what’s happening, Sam, is you're seeing our commercial customers in particular being much more sensitive in terms of what's happening in the rate environment. And we're seeing them move balances from non-interest bearing into interest bearing, which I think you would expect in this environment. So that would be an additional factor on top of seasonality.

And would you expect that dynamic to continue into 2018 or what do we think about in terms of that?

At some point, they complete the movement that they want to make from one category to the other. Clearly, as rates continue to increase, we’re going to have commercial customers ask for some sharing of rates. But I think the mix shift should probably slow down as we move forward.

This is actually Josh on for Ken. Average wholesale funding showed a large sequential increase this quarter. Do you think there's potential to remix these wholesale sources into deposits, and then how you’re thinking about funding the loan growth going forward?

So we are actively thinking about what we need to do from a deposit rate perspective to bring wholesale funding down, particularly the overnight category. When we think about what we do on the commercial customer deposit pricing, we think about what rate we would provide to them relative to the cost of growth overnight funding or across wholesale funding. So I would expect that you’re going to see that continue to come down over time, and it should be an opportunity for us as we think about just the trade-off and the rate improvement when we move the commercial deposits. So I think if you take a look at in the period, in particular you’ll see this already down significantly that’d be in the overnight funding. And then going forward, we are focused on core deposit growth. Like I’ve mentioned in my comments, we grew 3% in core deposits year-over-year, which I think is a pretty good showing relative to our peers in the industry. We've had a lot of success with CD products and we are looking at some money market opportunities as well. So I think core deposit funding will be the primary way we’re going to fund going forward.

And we've heard from some of your peers that they’re seeing a pretty significant benefit from the rollover of their swap portfolios. Could you just speak to what you're seeing in regards to this?

So at this point, all of our asset swaps are off at this point. We have no asset swaps on. The last asset swap rolled out in the first quarter. We evaluate some of the debt swaps we have inside the time, and that represents an opportunity for us, but have not taken any action there as of yet. Josh, does that answer your question?

I was actually referring more to the rolling over the spreads, so better new money spreads versus what's rolling off as that liability side swap portfolio rolls.

Clearly, we probably do have opportunities there. I don’t think it would be large in the scheme of things for us.

I want to start first on the loan growth. You guys have really solid C&I loan growth in the quarter. And Steve, you’re very optimistic in regard to business confidence, the economic strength of the footprint. As you look at the pipeline, could the high single-digit growth you put up this quarter on average loans continue in the second quarter or is that really just an anomaly the way you look at it?

The pipeline that we came into the year with was very strong. We had a surge in activity late in the year. So first quarter was very, very good with the carryover pipeline. As we come into the second quarter, we also have a sound pipeline across all segments of our businesses. And so there is an underlying sense of economic activity that we’re able to participate in through our customers that we would expect to carry forward with the year. We clearly are seeing more CapEx related investments than we have in quite a few years at this stage, Steven.

So is that why the average was so strong in the quarter as your customers spending? I mean, the line utilization increased in the quarter?

Our line utilization was off just a tick, so that really didn't benefit all that much. I do think we’ve seen more of an evening out of where the growth is coming from. Core middle market has been good. I think we are not seeing the impact we saw last year in the large corporate space. I think we’re actually seeing a bit of a pickup there and then some of the equity as well. So, it’s good broad-based contribution. And as Steve said, the pipeline remains fairly strong.

And then for my other question, I want to follow-up on the commentary around digital initiatives and what you’re doing on the customer experience side. What is the expected spend on technology this year and how does that compare to last year? Thanks.

Steven, we don't disclose the spend on technology. I will say that it’s up year-over-year in terms of what we're investing in technology development. And I would also tell you that the portion of that allocated to digital is up significantly year-over-year.

This is actually Ricky Dodds for Matt. I just wanted to hear your thoughts on or is there a build going forward. We’ve seen a number of your peers have large reserve releases this quarter. Just wondering if you could provide some color for Huntington going forward. I know you have some FirstMerit renewals and you have stronger loan growth. But wondering if you could provide a little more color there?

Well, in the quarter clearly with the loan growth that is going to come as additional reserve, so that's a large piece of it. The FirstMerit impact is still there, although that’s lessening each quarter. And then we did have some modest migration on the credit side and non-accrual loans that also contributed to the build. But as we’ve said over time, we expect the level of provision to moderate with both loan growth and more normalizing credit performance. Although, we expect the net charge-offs to continue to be below our long-term expectation. So as we’ve said, it’s low build back up in the reserve but it will be modest and a slow ramp.

And then maybe just a follow-up on loan growth. It was particularly strong and you guys called out the core middle market. I was wondering if you could provide any specific colors on industries or geographies, and maybe outperforming our verticals, just wondering if you can add any color there.

Well, I think obviously in our heavy manufacturing market rates, in particular, we're seeing strong demand there. But throughout our region, we have many areas that are involved in manufacturing. Chicago continues to be a strong growth market and that is far more diversified. I would say really most industries that we're looking at, I would say would have a positive outlook manufacturing wholesale, etc. And so really pretty good reads from all of our customers across most industries.

I wanted to ask about the revenue side, where the only weakness was in two areas: loan sale gains and mortgage banking. I'm curious about the $15 million to $18 million that has now decreased to $8 million to $10 million in loan sales. Also, is mortgage banking seasonal? Have you observed any improvement in pricing or originations for the second quarter in that fee line item?

So on the loan sale question, I would tell you that a lot of in this timing of SBA in the first quarter. So originations are actually up year-over-year. So good continued progress there, particularly as we move into Chicago and Wisconsin. So I view this as really a timing issue on most part. In the first quarter of last year, we did have a large equipment sale that contributed at the first quarter. And those are lumpy, as you know, so that again is a timing issue. On the mortgage origination side, again volumes were up, but favorable spreads are down. And a lot of the origination pickup has come from the FirstMerit expansion into Chicago and Wisconsin. I would also tell you we’re getting stronger in some of the core markets, primarily on the FirstMerit side. So we’re pleased with what we’re seeing from an origination perspective. But again, the sale of spread being down that’s impacted the fee line.

Purchase accounting accretion is something we have to deal with, and it has affected how the market perceives our earnings. Looking back over the past year, you reduced your first accounting accretion by half, maintained your margin, and actually increased net interest income. Do you feel that, given the guidance, you are quite confident? As that headwind slows down balance sheet growth, do you think core margin expansion will start to gain momentum despite any losses you might incur from purchase accounting accretion?

I am very pleased with what we are seeing in the core margin. We’ve increased a few basis points per quarter since the first quarter of 2017, and we expect that to continue in 2018 as well. So right now, the guidance we’re giving is flat to the reported margin as we continue to burn off the purchase accounting accretion. Could it be a little bit better? It might be. It just depends on where deposit pricing goes and what it’s going to take to fund the balance sheet. But I’m really pleased with how we come through the runoff in purchase accounting. And I think it really is disciplined pricing on both the asset and the liability side that’s allowed us to do that.

If we consider the current flat fed funds, your core margin is still on the rise. You pointed out that market rates exceed those of the portfolio in both securities and loans. Given the stagnant rates we have now, is it reasonable to expect an increase in yields?

Yes, I would agree with that. As we look at new money rates, they are generally higher than what’s in the portfolio. We still have some purchase accounting impact that we’re swimming through there. But again, we’re very disciplined in how we think about pricing the asset side of the balance sheet. And even in a flat environment, we’re going to continue to see new money come on at higher rates in the portfolio.

You guys talked about the seasonal increase in expense in the second quarter. I’m just wondering if that would be offset with a seasonal increase on the revenue side, and so therefore, maybe the efficiency ratio should be at least steady in the second quarter?

So typically, we do see a seasonal increase in revenue in the second quarter. The two are disconnected, of course, because the increase in expense has primarily to do with just the timing long-term equity compensation, as well as seasonal marketing, which typically is higher in the second and third quarters and then declines in the fourth quarter. So based on that, it wouldn’t surprise me if the efficiency ratio stayed at the same level, because we do see seasonality in revenue to the upside in the second quarter.

And then second separate question, it’s minor, but there was that uptick in non-performing assets. And I understand there’s volatility at the bottom. But could you just give us a little bit of color on the increase in NPAs this quarter?

So not industry driven, we have from time-to-time when you’re down at very low levels of NPAs any couple of credits can move that we had three credits in the quarter that are unrelated in industries. So no trends that we’re overly concerned about. It was really idiosyncratic events, particularly to those three individual credits.

I want to revisit the comment about deposit betas. It appears that you might be being cautious with the 50% deposit beta, which isn’t reflected in the current numbers. Are you observing caution on the commercial side? You mentioned a potential change in categories that is influencing some of those remarks.

So the 50% reference would be to any rate increases in 2018. So that might be a little conservative as we think about it. But again, we’re very focused on growing core deposits. If you take a look at across our region and who we compete with, we think it’s very rational. We see what’s happening, and there are lots of testing from a pricing and product perspective. We’re doing the same thing. But clearly, I think it’s a good assumption for us to think about for 2018 just given the environment and the desire for us to continue to grow.

We do see growth opportunity out there. And we feel very comfortable because the quality of the borrowers that we’re originating credit for is really in the super prime range. So I think given the fact that we’ve expanded our markets, there is a big universe out there. The competition is not as robust as in say indirect auto. But we’re originating at 90 plus FICOs for bid price both in RVs with folks with demonstrative liquidity; all these deals are individually underwritten. So we believe that there is potential out there for high-quality assets. We have established a concentration limit so our growth will be moderated by that limit. But we have plenty of runway that we think will serve us well as we develop that business further.

Just following up on Brock’s question, I hate to go back to deposit beta again. But basically, what you’re saying is at this point you're performing just like everybody else in the mid-teens. But going forward from here, you expect the pressure to step up. That's all you’re saying. Is that right?

Jon, I think we’re building that into the way we’re thinking about the forecast. Again, we like to be conservative from a rate outlook perspective. We like to understand what the revenue environment is going to be. And then from that, determine what investments we want to make and how we manage the expense line. So it just keeps us from web selling but the business segments and the colleagues in terms of everyday out there doing their job. So I think that’s exactly the way we stated that.

Related question on the revenue growth guidance is the same at 4% to 6% as the prior quarter but we did get the March increase. It would get a couple more is the macro view of the world that the margin can drift higher?

Yes, I think it can. I mean keep in mind that as I mentioned earlier, a 25 basis point increase is worth $25 million in full year basis. That’s about 0.5% growth in revenue. So the 25 basis point increase in March wouldn’t cause us to change our revenue guidance of 4% to 6%. But clearly, in a rising rate environment, if we get increases as might be expected, I would expect the margin to move higher.

So thank you very much. We feel very good about where we are. We obviously produced good results in the first quarter. And we're confident about our year going forward. Our top priority is growing our core businesses and that's continuing, and we think there's more opportunity at hand, certainly throughout the year. We're building long-term shareholder value with top quartile financial performance, and we're maintaining strong risk management with disciplined execution across our strategies. So I like the performance and position but feel we have upside opportunities to do better in a number of businesses. So finally, I'd like to include a reminder that there's a high level of alignment between the board, management, our colleagues, and our shareholders. Collectively, the Board and colleagues are the seventh largest shareholder in Huntington and all of us are appropriately focused on driving sustained and, I want to emphasize, long-term performance. So thanks for your interest in Huntington. We appreciate you joining us today. And have a great day.