Huntington Bancshares Incorporated

Greetings and welcome to the Huntington Bank Share second quarter earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Mark Muth, Director of Investor Relations. Thank you, sir. You may begin.

Thank you, Michelle. 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 Steinhauer, Chairman, President, and CEO, Zach Wasserman, Chief Financial Officer, and Rich Pohle, Chief Credit Officer. As noted on slide two, 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 this blog and material filed with the SEC, including our most recent forms 10-K, 10-Q, and 8-K violence. Let me now turn it over to Steve for opening remarks. Thanks, Mark, and thank you to everyone for joining the call today. We're pleased with our second quarter results, which reflect solid execution across the bank, despite an incredibly dynamic and challenging operating environment. Revenue was essentially level with the year-ago quarter as record mortgage income offset pandemic-related headwinds. The actions we've taken to reduce our deposit costs, along with the hedging strategy we implemented in 2019, are helping to offset the impact from lower rates. Expenses were down year-over-year as a result of the proactive expense actions we took in the fourth quarter of 2019, as well as the new program we are implementing in 2020. Our business model, balanced between commercial and consumer, provides diversification of revenue. Of course, good performance is offsetting challenges. Our increased PPNR year-over-year reflects consistent execution of our strategies. Our purpose of looking out for people has guided our actions during these difficult times. I'm extremely proud of my colleagues and their continued efforts to communicate with and support our customers as well as each other. Over the past month, the bank funded more than 37,000 loans with a total volume of more than $6 billion through the SBA's Paycheck Protection Program, or PPP, to aid small and medium-sized businesses across our footprint. Huntington is well-positioned with robust capital and liquidity to remain supportive of our customers and communities going forward. Huntington received the highest score in the J.D. Power 2020 mobile app satisfaction study for regional banks. Now, this is the second year in a row we've been recognized by J.D. Power, providing evidence that our focused technology investments are being well-received by our customers. As we assess the outlook for the economy, we are guardedly optimistic for a gradual economic recovery. The unprecedented level of government stimulus has supported both individuals and main companies. Fed support has brought financial stability to markets. Recent economic headlines generally appear more positive, with homebuilder, auto, and RV and marine sales and sentiment exceeding pre-pandemic levels. U.S. consumer retail sales rose 7.5% in June as businesses have resumed operations. In our businesses, we saw record consumer mortgage origination activity in the second quarter. Our commercial pipelines have improved over the past few weeks, and our customers are becoming more optimistic for the future, with many manufacturing customers expecting to be back to pre-pandemic activity levels during the second half of the year. Our outlook reflects consensus view of economists that the recovery is taking hold, but progress will be uneven. While we do see signs for optimism, we remain vigilant to possible risks, and our disability is generally limited to the next few months. The range of potential outcomes on key metrics remains wide. We are monitoring economic and customer data closely and tightly, managing our businesses. As a result of lower interest rate levels, we are taking actions to manage expenses this year, which Jack will further describe. We remain disciplined on expense growth while making further investments in technology and other strategic business initiatives as the economy recovers. And as we've discussed previously over the past decade, we have fundamentally changed Huntington's enterprise risk management. It's now a strength of the company as compared to a weakness during the prior cycle. The most recent DFAS results demonstrate superior credit performance for our fifth consecutive DFAS piloting. Our model QM loan losses in the Fed's severely adverse scenario remain among the best in the peer group, while our stress capital buffer established at the minimum level of 2.5%. Our commitment to an aggregate moderate to low risk profile is illustrated through the DFAS results. Our second quarter credit metrics remain sound as we address the issues in our oil and gas portfolio. With our second quarter provision, We believe we have the loss exposure in the oil and gas portfolio fully reserved. Our underlying portfolio metrics continue to reflect our expectation for outperformance through the cycle. We restrained our commercial lending in 2019 with a fourth quarter average year-over-year growth rate of 1.8%, which gives us a more seasoned portfolio of commercial loans at this point in the cycle. morning we announced that the board declared the third quarter cash dividend of 15 cents per common share unchanged from the prior quarter. Based on what we know today, management expects to maintain the quarterly dividend rate in the fourth quarter, subject to the board's normal quarterly approval process, and you'll hear more about the dividend from Zach as well. So Zach, I'll ask you now to provide an overview of the financial performance and carry forward. Thanks, Steve, and good morning, everyone. Slide 3 provides the highlights of the 2020 second quarter. We reported earnings per common share of 13 cents, return on average assets was 51 basis points, return on average common equity was 5%, and return on average tangible common equity was 6.7%. Clearly, results were significantly impacted by the elevated level of credit provision expense as we added $218 million to the reserve during the quarter. Now let's turn to slide four to review our results in more detail. Year over year, pre-tax, pre-provision earnings growth was 4%. We believe this is solid performance in light of the challenges of the interest rate environment and the rapid decline in short-term rates year to date. Total revenue was relatively flat versus the year-ago quarter, as pressure on spread revenues was nearly offset by growth in fee incomes. Specifically, record mortgage banking income of $96 million was partially offset by waivers to assist our customers, reduced customer activity, and the higher levels of consumer deposit account balances that reduced the deposit service charges and cards and payment fee line items. Total expenses were lower by $25 million, or 4%, from the year-ago quarter. This expense discipline reflects the actions we took in the 2019 fourth quarter to reduce our overhead expense run rate, including a reduction of 200 positions and the closure of 31 in-store branches, as well as the actions we have taken to adapt to the current environment, balanced against the impact of continued investment in our technology capabilities. Finally, I would like to note that the normal size continuing comparisons for our net interest income, fee income, and non-interest expense can be found in the appendix. Turning to slide five, net interest margin was 2.94% for the quarter, down 20 basis points linked quarter, in line with the guidance we provided at the Morgan Stanley Conference in June. The second quarter NIM was negatively impacted by a few unusual items that I would like to highlight. Elevated deposits held at the Fed during the quarter reduced NIM by seven basis points versus the first quarter. This impact would have been larger, but for our active management, to move several billion dollars of non-primary bank relationship account balances off the sheet during the quarter. Reduced loan late fees, primarily in our auto portfolio, compressed NIM by three basis points. Additionally, in Q2, NIM was negatively impacted by three basis point derivative ineffective dis-mark, while in Q1, the mark was positive four basis points. Thus, seven basis points of the 20 basis points of quarter to quarter NIM compression was driven by this item. Our underlying NIM performed quite well despite the challenging interest rate environment. Given our strong liquidity position, we continue to actively manage down our cost of funds. Our average cost of interest-bearing deposits was 25 basis points in the month of June, and we see some continued opportunity for modest further reduction. Our hedging actions continue to reduce the unfavorable impacts of interest rate volatility and the lower interest rate environment. In the second quarter, we had $1.6 billion of forward-starting asset hedges become active, providing NIM benefit going forward. Moving forward to slide six, average earning assets increased $9.9 billion or 10% compared to the year-ago quarter. Average commercial and industrial loans increased 15% from the year-ago quarter and 14% linked quarter, reflecting the addition of $4.1 billion in average PPP loans. As of quarter end, the total PPP loan balance was just over $6 billion. Outside of PPP lending, we saw solid growth in health care and asset finance in the quarter. Offsetting this growth, auto floor plan line utilization was suppressed due to lack of new inventory from OEMs, and we continue to actively manage the non-core exposure in our oil and gas portfolio down, including $170 million of loans sold, or under contract to be sold in the second quarter. Consumer loan growth remained focused in the residential mortgage portfolio, reflecting robust originations over the past four quarters. Also, as a result of the elevated deposit levels in the quarter, we saw a material increase in interest-bearing deposits being held at the Fed. Turning to slide seven, we will review the deposit growth. Average core deposits increased 13% year-over-year and 12% versus the first quarter. primarily driven by commercial loan growth related to the PPP loans and commercial line draws, consumer growth related to government stimulus, and reduced account attrition. During the quarter, we saw dramatic shifts in the retail deposit acquisition trends as consumer and business banking customers adapted to the COVID environment. We saw utilization of online account opening channels increase 13% quarter over quarter and 61% year over year. we are now seeing traditional branch-based acquisition approaching pre-COVID levels. Slide 8 highlights the trends in commercial loans, total deposits, saleable mortgage originations, and debit card spend, which is consistent with what we disclosed at last month's Morgan Stanley Conference. Slide 9 illustrates the continued strength of our capital and liquidity ratios. The Common Equity Tier 1 Ratio, or CET1, ended the quarter at 9.84%, down four basis points year over year. The tangible common equity ratio, or TCE, ended the quarter at 7.28%, down 52 basis points from a year ago. Let me turn it over now to risk to cover credit. Rich? Thanks, Zach. Before I get into the second quarter credit results, I want to turn your attention to slide 10, which illustrates the relative rankings of modeled cumulative loan losses for Huntington and our peers in the Federal Reserve's severely adverse scenarios of the 2020 DFAS exercise. As Steve has mentioned over time, this is the only true comparison of credit risk across the sector that we know of, and it provides us independent validation of the credit risk management discipline and practices we have been implementing for over a decade now to achieve an aggregate moderate to low risk profile. Our 2020 DFAS result puts us at the top of our peer group, and we've been a top quartile peer performer in each DFAS exercise since 2015. Our portfolio composition, evenly split between consumer and commercial businesses, gives us diversification in periods of economic stress, and our DFAS numbers reflect as much. Turning now to the credit metrics and results. Slide 11 provides a walk of our allowance for credit losses, or ACL, from year end 2019 to the second quarter. You can see our ACL has more than doubled during this period, increasing by just under a billion dollars to 2.27% of loans. Excluding the PPP loan balances, our ACL would be 2.45% as of June 30th. The second quarter allowance represents a $218 million dollar reserve bill from the first quarter. Like the first quarter, there were multiple data points used to size the provision expense for Q2. The primary economic scenario within our loss estimation process was the May Moody's baseline forecast. This scenario assumes peak unemployment in Q2 2020 at 15%, followed by a rebound to 9% by the end of 2020, and a slow recovery to 8.5% by the fourth quarter of 2021. GDP recovers from a 33% decline in 2020 to end the full year down almost 6% and demonstrates 1.5% growth in 2021, with most occurring in the second half of the year. The Q2 ACL now includes a 30% reserve against our oil and gas portfolio. We believe we have the lost content in this portfolio fully reserved. We have bifurcated this portfolio into core and non-core segments. with the non-core portion representing just under 60% of oil and gas borrowings. Our 30% coverage includes a 44% coverage ratio against the non-core portfolio and a 9% reserve against the core portfolio. Recall that our oil and gas portfolio represents about 1% of total loans. Slide 12 shows our NPAs and TDRs and demonstrates the impact that our oil and gas portfolio has had on our overall level of NPAs. We have discussed for several quarters the challenges we see with this portfolio. Commodity prices continue to range below economical levels for this industry. Oil and gas MPAs represent 40% of our overall MPAs and are also a significant contributor to our Q2 MPA bill. Notably, over 95% of our oil and gas MPAs were current pay with respect to principal and interest F of quarter M. Slide 13 provides additional details around the financial accommodations we've provided our commercial customers. The commercial deferrals are now graduating to amendments and waivers, and outside of the hospitality and other travel-related businesses, we do not see a widespread need for additional payment relief. Our auto dealers and franchise restaurant customers, two of our larger deferral users, are both exiting those deferral periods in strong shape, and we expect nearly all those deferrals to run their course in Q3. Today, requests for additional deferral periods have been limited in the other commercial portfolios as well. Slide 14 shows our consumer deferrals, and the early news here is good as well. Our auto, RV, marine, and HELOC portfolios are performing as we would have expected, with modest post-deferral delinquencies. Our focus on high FICO customers here has shielded us somewhat from job losses we have seen. The mortgage accommodations are a two-step process. as a new forbearance agreement is necessary upon the expiration of the first. As a result, we have limited visibility to the resolution here. Slide 15 provides an update to the industry's hardest hit by COVID-19 to date. We have thoroughly reviewed these portfolios, as well as 75% of our total commercial loan portfolio since April, and believe we have the existing risks identified and appropriately managed. Our hotel exposure is centered on five primary sponsors. Most of them are long-term relationships, including through the last downturn. We believe these sponsors have the liquidity and financial flexibility to see their way through the longer-term recovery period we forecast for this industry. Our restaurant exposure is primarily in the national quick service brands that have maintained drive-up operations, and our sandwich and pizza customers have been open for takeout service to offset the declines in in-house seating. We believe this book to be in good shape overall, but we'll continue to closely monitor the heightened risk in the single location and other non-franchise names in the portfolio. As a leading SBA lender in the country, we also have guarantees on over $400 million of the restaurant, childcare, physician's practices, and other sectors, which provides us additional opportunities for recoveries. In the second quarter, as part of our active portfolio management process, we evaluated the COVID-related impacts across all portfolios and took appropriate actions, as required by regulatory guidance, to downgrade those severely impacted credits to criticized status. This review resulted in an increase to our criticized asset level of $1.1 billion in the quarter. As you would expect, they were centered on the industries referenced in the chart, hospitality, retail, airport parking, and auto suppliers. The customers in these affected industries except for auto but have longer paths back to a full recovery, and we felt it prudent to move those credits to criticize status. We will take a patient approach to working with these customers and currently do not see a significant loss content. Of the 30% of the downgrades we did not attribute to COVID, most of that was in our oil and gas portfolio. Slide 16 provides a snapshot of key credit quality metrics for the quarter. Our credit performance on the whole was strong. Net charge-offs represented an annualized 54 basis points of average loans and leases. The commercial charge-offs were centered in the oil and gas portfolio, which made up approximately 75% of the total commercial net charge-offs. I would also point out that nearly all these oil and gas charge-offs resulted from loan sales closed or contracted for sale during the quarter, as we prudently reduced our exposure to this industry. Annualized polio net charge-offs, excluding the oil and gas-related losses, were 24 basis points, demonstrating that the balance of our portfolio continued to perform well in Q2. Consumer charge-offs were down to 30 basis points in Q2, demonstrating our continued strong consumer portfolio. As always, we have provided additional granularity by portfolio in the analyst package in the slides. The non-performing asset ratio increased 14 basis points per quarter and 28 basis points year-over-year to 89 basis points due to the oil and gas impact I described earlier. Let me turn it back over to Zach. Thank you, Rich. Turning to slide 17, I will provide our expectations for the third quarter. As was the case last quarter, we feel it prudent to limit our guidance to the current quarter due to the ongoing uncertainty around the economic outlook. As Steve alluded to earlier, we have confidence in our businesses and are pleased with our second quarter results given the headwinds in the quarter. Our sentiment has improved from 90 days ago due to the recent trends we're seeing and the actions we've taken to better position the bank for success going forward. Looking at the average balance sheet for the third quarter, we expect average loans to be approximately flat on a length quarter basis. Consumer loans are expected to increase approximately 2% driven by continued growth in the residential mortgage and RV and marine lending. Commercial loans are expected to decrease approximately 1% as the full quarter impact of PPP is more than offset by continued reductions in dealer floor plan and commercial loan utilization rates. Our current projections assume the majority of the PPP balances will remain on the balance sheet through the end of the year. Our early stage commercial pipelines have been building over the past several weeks, supporting the expectation of accelerating growth in the latter part of the year. We balance this customer optimism with an acknowledgement of the fluidity of the current economy and some concern that the recent upward trend in the infection could dampen the pace of the economic recovery. We expect average total deposits to decrease approximately 1% length quarter. Commercial deposits are expected to decrease approximately 3%, assuming gradual usage of deposit inflows from the government stimulus. We expect total revenue to increase approximately 2%, linked quarter with the net interest income increasing 2 to 4%. We expect GAAP NIM to expand approximately 7 to 10 basis points versus the second quarter NIM of 2.94% as a result of the hedging strategy and the elimination of notable items which negatively impacted the second quarter, namely three basis points of reduced loan rate fees and three basis points of derivative ineffectiveness mark. Our NIM expectation does not include material benefit from the acceleration of PPP fees from the repayment or forgiveness of those loans in the third quarter. We expect fee income to be approximately flat as mortgage banking activity remains robust and pandemic impacted revenue lines rebound. Based on the debit card trends, we would expect a slight pickup in card related fees in the third quarter. Deposit account activity volumes are increasing. Yet given the elevated level of consumer deposits, we do not expect a full recovery in deposit service charges. These increases are expected to be offset by reduced other income as the second quarter contained gains of $18 million related to the annuitization of a retiree health plan and the retirement plan services record keeping business sale. As I mentioned earlier, we are benefiting from the expense actions we took in the fourth quarter of 2019. In addition, given both the significant economic challenges of 2020 and the desire to self-fund some of the compelling initiatives being identified in our ongoing strategic planning process, we are now executing the expense management program we have previewed for you on prior calls. As I mentioned previously, our outlook to this plan is focused on four categories of expenses, the size and compensation level of the organization, structural expenses, including our branch and corporate facilities, investments, primarily the optimization of the level of marketing, and lastly, other discretionary expenses. This program is sized to generate approximately $75 million of annual savings in 2020 and 2021. In 2020, this cost rationalization will allow the bank to prudently manage expenses given the economic and business uncertainty that exists this year. We've modeled numerous scenarios, for the 2020 financial outlook, with the majority of these forecasts achieving positive operating leverage for 2020, inclusive of the expected approximately $25 million of restructuring costs related to the expense management program. Importantly, we've been positioning the company for some time to be ready to capitalize on opportunities to drive accelerated revenue and market share growth that will arise when the economic recovery begins to solidify. While our longer-term planning for 2021 is still a work in process, our current expectation is that if we continue to see positive signs of economic stabilization and regrowth, we will accelerate investments in digital technology capabilities, product differentiation, and other strategic initiatives in the latter part of 2020 and into next year, potentially utilizing up to the full amount of these savings for this purpose in calendar year 2020. Thus, this program provides the opportunity to fund these initiatives while generally maintaining a strong expense efficiency level in 2020. Focusing on the expense outlook for the third quarter, we expect non-interest expenses to increase approximately 5% on a linked quarter basis. Approximately 2% of this growth is driven by the $15 million of the total approximately $25 million for structuring costs associated with the expense management actions that we recognized in the third quarter. The remaining approximately 3% is driven by investments in technology and marketing, as well as the return of customer and sales activity closer to pre-pandemic levels. Finally, we expect net charge-offs in the third quarter to be near 65 basis points. This is reflective of the potential charge-offs in the oil and gas portfolio, as well as broader economic considerations. Fundamentally, our credit remains sound. However, the economic outlook remains uncertain, and we are likely to see elevated provision expense through the remainder of 2020. 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 any additional questions, he or she can ask themselves back into the queue. Thank you.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to move your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for your questions. Our first question comes from the line of John Armstrong with RBC Capital. Please proceed with your question.