Huntington Bancshares Incorporated (HBAN) Earnings Call Transcript & Summary

Thank you, everyone. This is Jon Arfstrom from RBC Capital Markets. And I guess, it's officially good afternoon on day 2 of our conference. We have today Zack Wasserman, the Chief Financial Officer of Huntington, along with the rest of his Investor Relations team. And I want to thank Zack and Huntington for being flexible with the virtual format. We -- as I think all of you know, we had this set as a live conference in New York, but it will be live from Columbus today. And before you start, Zack, I'll just say, there's a lot of volatility with rates in the market and commodity moves, and it's challenging. And I just want to say how much we appreciate the presentation that you filed this morning. For those who haven't seen it, Huntington provided some deeper discussion around the hedging program and repricing opportunities and then some reminders of their overall fee system. We just do appreciate the extra work on that. To the investors listening, there should be some time for Q&A at the end. I want to remind everyone that you can ask questions through the webcast. And we'll get to as many of them as we can. So with that out of the way, live from Columbus, take it away, Zack.

Well, thank you so much, Jon, and it's a pleasure to be here with all of you. I'd like to begin with a big thank you to RBC for their thoughtful leadership to adjust to a virtual conference format in light of the current events. I also want to thank you all for joining us today on the webcast and for your continued interest in and support of Huntington. As Jon said, I'm joined today by our Director of Investor Relations, Mark Muth. Before we get started, let's turn to Slide 2 of the presentation. Please read and understand this slide, as we will be making forward-looking statements today. Given the current circumstances, we decided that rather than present a traditional slide deck discussing our long-term strategy and some of our various growth initiatives, I would instead provide focused remarks on the current market environment, some of the actions we are taking and the insights into what we're seeing from trends in our business and from discussions with our customers. I'll then turn it over to Jon for Q&A. I'll begin my comments by highlighting what you all know. Over the last month, we have witnessed the rapidly evolving concern about the coronavirus which added to the preexisting sources of uncertainty, which is now significantly impacting financial markets and economic outlook. Concerns about the spread of the disease are driving fear of a U.S. and global recession. This is compounded by the natural concerns about the health and safety of colleagues, customers and communities. While most of our customers are yet to feel material effects, all have seen the unprecedented low levels of interest rates and the rapid sell-off in equity markets, both of which raised the specter of a near-term recession. More recently, we've seen dramatic movement in the price of oil, which adds to preexisting difficult pricing environment for natural gas. These changes present material challenges to the financial performance of the banking sector broadly and our company. The interest rate environment puts significant pressure on spreads and revenue growth. Concerns about the broader macro economy impact loan demand, credit quality among myriad other factors. We manage our company in this environment with our eyes open about the challenges. We're focused on understanding the impacts and proactively managing to mitigate these risks. We're also mindful of our mission: to support our customers and our community by being a source of stability in times of uncertainty. So we are being thoughtful and rational in our actions. The visibility we have into just how long the situation will last and how deep the economic impact will be felt is low. On one hand, there are clearly reasons to be concerned. On the other, we also note the possibility that the virus will be contained and that we will see a recovery to a more normalized environment over the course of 2020. In addition, there is the potential for positive effects on the broader macro economy from lower interest rates and gas prices as well as government support actions. We are taking steps in our business, including efforts to manage our revenues through deposit interest rate reductions and loan production mix, actions to reduce our expenses while preserving our critical long-term investments, continuing our credit underwriting posture consistent with our aggregate moderate-to-low risk appetite and ensuring the safety and soundness of the institution is maintained. Given the uncertain environment, I will not be providing updated full year 2020 guidance today. However, I will walk through some of the trends we're seeing and expand on the actions we're taking. In times like this, the temptation is to focus solely on the volatility, the distractions around us. However, we have a company to run and strategies to execute and we are doing so. For example, last month, we completed the previously announced closure of 30 Giant Eagle in-store branches. We're extremely pleased to be able to place 97% of impacted colleagues into other roles within Huntington, and customer and balance retention are in line with our expectations. We're also driving forward our digital and technology strategy, including the current phased rollout of important new functionality and our J.D. Power award-winning mobile banking app, which among other strategies continues to fuel engagement growth in our consumer banking franchise. And we continue to execute on our strategic plans for capitalizing the momentum in our commercial banking and fee-based businesses. Now turn to Slide 4 to discuss some of what we're seeing and how we're addressing the current environmental challenges. Taking a step back from the recent market disruptions, the underlying health of the economy across our footprint as we entered Q1 was quite solid. Key economic indicators at a national level and for our footprint states pointed to economic expansion. Consumer confidence continued to demonstrate strength, and we're seeing that manifest in our robust consumer lending businesses in Q1, especially home lending and auto finance. Last summer, we made the decision to drive increased fixed rate asset originations from our consumer businesses, specifically in home and auto lending. It is also important to note that we are driving increased production while maintaining our prime -- super-prime customer focus and our consistent underwriting discipline. Home lending is extremely robust. The recent decline in long-term interest rates is driving a mortgage refinance wave, resulting -- and resulting fee income that provides a natural hedge to reduce some of the pressure on spread revenues. Following record mortgage originations for both full year 2019 and the fourth quarter of 2019, in February, our home lending business saw a new record level of activity with $1.4 billion of mortgage applications for the month and the single highest day of applications on multiple days. The 2019 fourth quarter was also a record for auto originations. While seasonality will preclude us from setting a new record in the first quarter, we continue to see strong auto originations. We are reaching out to our business and commercial customers to gauge the potential impacts of the evolving environment. As you would expect, we have seen a wide range of reactions and commentary. Similar to our reactions, we are seeing commercial customers widen their business readiness exercises and ensuring that technology and system redundancies already where possible. With respect to supply chain concerns, while China is an important trading partner to manufacturers in our footprint, Mexico and Canada play a larger role. So the recent USMCA ratification will be a positive event. Slide 5 illustrates the dramatic year-to-date shift in the yield curve. While most of you are fully aware of the rapid severe downward movement in the 10-year swap yield and the recently lowered short-term end of the curve, I wanted to direct your attention to the belly of the curve, which is represented on this slide in the 2-year and 4-year swap yield columns. While we are currently well positioned from a hedging standpoint for the changes in the short end of the curve, we are feeling pressure on spread revenues from the drop in the belly of the curve and the longer end. New money yields on securities are down roughly 85 basis points since the fourth quarter. As we will reinvest approximately $1 billion of securities cash flows this quarter, this incremental 85 basis point decline equates to approximately $8.5 million reduction to annualized revenues, all else equal. While we are taking other tactical actions to support net interest income, we expect to see continued reinvestment risk going forward. Similarly, portfolio mortgage originations have yields more than 60 basis points below the existing portfolio rate. However, importantly, offsetting this unfavorable impact on spread revenue, we saw a dramatic expansion of secondary marketing spreads in February for the saleable mortgage originations, driving meaningful upside in mortgage banking fee income that is partially offsetting the pressure on NIM. To date, we've not seen material reductions to our auto loan originations. Slide 6 summarizes the actions we have taken to reduce the impact of lower interest rates. As shown in the pie chart on the upper right, the combination of the portfolio mix shift and our hedging activities have reduced the portion of our loan portfolio exposed to the changes in 1-month LIBOR or prime rates to approximately 25% of total loans. The tables on the bottom of the slide provide details regarding some of the tactics employed in our hedging strategy. The table on the left shows hedges that are currently active, while the table on the right shows details -- the forward-starting hedges that will become active over the next 2 years. Slide 7 focuses on the funding side of the equation. Both repricing and retention rates for the maturities of the promotional price deposits continue to perform as expected. Consumer deposit pricing remains rational in most markets. Last week, we reduced our promotional deposit pricing 50 basis points, the day before the Fed's unexpected rate reduction. We will look for opportunities to continue to reduce consumer deposit pricing where possible. On the commercial side, we are executing repricing actions correlated to the recent rate cut with client-specific rate reductions, particularly among our highest cost deposits. However, deposit pricing for certain large commercial customers, particularly for the new business, continues to be challenging. We have refrained from paying up for these higher cost deposits, opting for lower cost funding sources. While we continue to be pleased with the performance of our funding strategies, the previously mentioned asset yield pressures are offsetting the improvement from reduced deposit costs. Volatility of the rate curve day-to-day makes it very difficult to provide additional revenue guidance at this time. However, we remain diligent in our efforts to stabilize our NIM, and we are benefiting from continued growth in certain noninterest fee revenue streams, particularly mortgage. Despite the more challenging revenue outlook, we remain committed to targeting positive operating leverage. This is the right posture for the company over time, and we like the discipline it forces to ensure our investments drive appropriate returns. As we have done in the past, we will take actions to manage our expenses so that we can continue to invest to drive longer-term revenue growth, while staying true to the objective of positive operating leverage. Therefore, we are currently making adjustments to our planned 2020 expenses. We have a continual expense contingency planning process, and we have effective options to manage in 2020. These plans include reducing discretionary spending, the pacing and focus of longer-term investments, optimizing our branch network and the size and compensation levels of our organization, among other levers. Philosophically, we manage the business for the long term. There could be a time when we decide that the return on our -- on the investments we are making warrants continuing to grow expenses in a specific period where revenue growth is not commensurate. If and when we do this, we will communicate it. We have not reached that point today. Moving on to Slide 8 and credit performance. Overall, credit is performing well as we continue to see generally in-line trends in delinquencies and credit performance across our portfolio. We continue to see opportunities to grow lending in line with our aggregate moderate-to-low risk appetite. While it is too early to see any impact from the coronavirus in specific customer's financial performance or credit outlook, the energy portfolio remains an area of significant stress due to low commodity prices and scarcity of capital. This portfolio represented less than 2% of loans at year-end, and we continue to work diligently to reduce this exposure. As we have noted on the fourth quarter earnings call, the energy portfolio is a primary driver of the outlook for increased charge-offs in 2020. We're also focusing -- forecasting lower recoveries in 2020, given the modest charge-off numbers in the recent prior years. On CECL, consistent with the inherent pro-cyclical design of the methodology, we would expect meaningfully elevated provisioning over the next few quarters to reflect the deterioration in the economic outlook currently reflected in equity and debt markets. It remains too early to know the ultimate impact on first quarter provision expense as other key components, including the composition of the loan portfolio at quarter end, any potential changes to the assigned weightings of the various economic scenarios and any qualitative reserve additions we may deem appropriate. Slide 9 provides a snapshot of our balance sheet strength. With robust levels of capital and liquidity, we are taking a highly proactive stance to manage our balance sheet to maintain this strength. We remain prudent with our allocation of capital, and our capital priorities have not changed. As we previously communicated on many instances, our capital priorities are: first, to fund organic growth; second, to support the cash dividend; and finally, all other capital uses. As we communicated in our Q4 earnings call, we previously intended to utilize less than 1/3 of our remaining share repurchase authorization in the first half of 2020 as we rebuild our capital ratios from the negative impact of CECL implementation. We continue to believe that a position of capital strength is the right positioning at this point of the economic cycle and given the elevated market volatility. However, the optimal deployment of the company's capital is a continual process that we manage every day. During Q1, we decided to utilize modestly more of the remaining share repurchase authorization than originally planned. With activities executed in Q1, we are on track to utilize closer to half of the remaining authorized buyback. We will continue to evaluate our plans for Q2 as the market and economic environment clarifies. It remains too early to know what our 2020 CCAR ask will entail. I will conclude by highlighting a few key messages. We continue to see sustained traction on our long-term strategic growth plans. We exited 2019 having taken a series of actions designed to improve 2020 financial performance, and we are significantly benefiting from these actions now. However, recent market volatility and economic concerns make visibility into 2020 difficult at this time. We expect pressure on our 2020 revenue, but the magnitude remains to be determined. There is clearly pressure on NIM, but we have partially offsetting benefits in our hedging and deposit pricing. Fee income will perform above expectations in a variety of areas, led by mortgage. We are focused on what we can control, driving prudent growth, maintaining rational loan and deposit pricing and executing our business plan. We continue to see strength in our consumer markets and product lines. The refinance boom, coupled with lower gas prices at the pump, will benefit consumers with additional discretionary spending capacity. Our business and corporate customers remain cautious. We are active stewards of expenses to drive returns and positive operating leverage. We have levers to manage toward this goal, but our orientation will always be to prioritize long-term sustainable value creation. Our balance sheet is strong, and our capital priorities have not changed, including supporting our dividend and rebuilding capital from the impact of CECL implementation. While we continue to see broadly stable credit trends, we do expect meaningfully elevated provisioning and charge-offs related to the energy portfolio. We are operating in this time of considerable uncertainty from a posture of strength, productivity and balance. And lastly, our brand promise is to look out for people. We remain committed to supporting our customers, our communities and our colleagues as a source of strength in this time of uncertainty. I will now turn it back to Jon to begin the fireside Q&A section.

Okay. Thank you, Zack, for that, very comprehensive, and we appreciate that. A lot of different places we could go. And I know there's some uncertainty. But you talked a little bit about -- earlier about economic activity in your footprint, and you've talked a bit about some of your loan growth objectives for the year. Anything that you see today that makes you change some of your thinking in terms of expectations for loan growth, both on the consumer side and commercial side?

Thanks for the question, Jon. Just I would reiterate that it's really uncertain, the environment. We walked into this year, having a quite positive outlook for the economy. There were a number of factors that were stacking up that were expected to help to drive economic growth, and the -- we look at the economic activity in the country overall, and in particular, in our footprint states in detail every month. And the leading economic indicators, the factors we were looking at were pointing to strength. And so that's the position we entered into Q1 with. Clearly, the market disruptions we've seen over the last several weeks and months loom large, and it really makes it difficult to say. As we sit right now, we feel -- we're watching the trends fairly in line with our expectations for Q1, the future is really too uncertain to call at this point.

Okay, that's fair enough. And then a little bit more on the consumer. You touched on auto lending a bit. But maybe expand a little bit on how that environment feels at this point? And maybe more in the -- what some of us would consider the leading edge of credit? Maybe touch a little bit on anything you might be seeing in RV? And are you watching something like that a bit more close?

Yes. It's a key question you're asking. And so there's sort of 3 parts to that question. I think consumer overall, auto and boat and RV. On consumer overall, I would say the trends continue to be extremely robust and we do not see any leading indicators that point to anything material changing in that. As I mentioned in my prepared remarks, the demand for mortgages is at record levels, just incredibly strong. And that's going to benefit us with fee income, as we talked about, that will offset some of the pressure on net interest margin. On the auto side, the pipeline also remains robust. Economy-wide sales in 2019, I don't think they were a record, but they are one of the top couple or 3 years ever in terms of auto sales. And as we go into Q1, we're still seeing signs of the same level of quite strong demand. One of the things that we're watching really closely are for any signs of supply chain issues, but we're not seeing that yet. We're monitoring floorplan utilization very closely, but not seeing any major changes at that time. We look at a couple of key factors in the auto business, the credit quality, the new -- the mix of new and used vehicles. And again, all of those are quite stable. This business is one that we're highly focused on the prime and super-prime space, and we really like where it's going. We've been in the auto business for 70 years. And so we know it very well. We've got deep relationships with the dealers that we work with. And so no real changes there. On the boat and RV process -- business, many of the same messages I would give. We really love the fact that, that business is focused on the super-prime space with an 800 FICO. It's got great yields, pretty low individual exposures between $40,000 and $50,000 per person. And we're focused on the towable and fresh motor markets that we think are resilient and in the places in United States that are -- where this activity is really part of the core lifestyle of our customers and therefore expected to be resilient through the cycle. I think one of the things that's important to note is that we're coming upon now the season of the big boat and RV shows, which often drive a number of sales. And so how those shows are managed in the face of the corona threat remains to be seen. And so we're watching that carefully. But broadly speaking, the trends we're seeing in the consumer business, I would characterize as robust.

Okay, great. On the margin, I respect and understand just how fluid this all is. But I just want to make sure that we're looking at it in the right way, the way you want us to look at it. On that Slide 6, in your hedging program overview, I think what you're saying to us is 40% of the loan portfolio is fixed. So there's likely maybe pressure over time, but not immediate. Another 19%, somewhat similar, that's hedged. So the remaining 40% or so, that's the part that is showing the pressure. Is that the right way to look at the loan yield side?

Yes, I think that's right.

Okay. And then offsetting that, you've identified about $13 billion in deposits, that's repricing over the next quarter or 2, is that right? And is there anything else we should think about in terms of the funding side?

Yes, I think the deposits that are repricing in the first quarter are around $4.8 billion to $4.9 billion and another $3.3 billion in Q2. The $4.8 billion from the fourth quarter of 2019 has already repriced. What I would tell you is, just on the topic of deposit repricing and so NIM more broadly, we entered 2020 with the expectation that 2 key factors were going to drive the continual increase in NIM that we had projected and communicated at that time. And most notably, the repricing of these promotional deposit rates; and secondly, the securities repositioning that we did during the fourth quarter, where we picked up quite a bit of yield on about $2 billion of securities, both those things are absolutely trending on plan. We continue to be executing that program with no deviation from our expectations. We also had our hedging program that we knew would protect us under certain Fed interest rate and short-term interest rate reductions. I think the thing that we talked about and you just noted is the impact that we're seeing is from the belly of the curve, and to some degree, from the fact that we've now gotten a number of rate cuts and now another, I believe, the interest rate outlook changes at this point almost every day you look at it. But the last time I looked yesterday was 3 additional rate reductions over the next several months expected that's baked into the curve. So that's the pressure we're seeing. I would say, we do absolutely have levers to continue to reduce our deposit costs. We're already executed on the -- on reducing deposit cost base that are correlated to the most recent interest rate reductions that we saw just recently. And we are seeing the upside in mortgage banking fee revenue, which is quite robust. That's about as much as we can say at this point. We're watching it and modeling out the future daily to make sure we understand where it's going. But I think those are the kind of the puts and takes that are driving the outlook.

Okay. I'd -- We could talk on this forever, but I just want to move along to credit quickly just in some of our remaining time. You talked about the meaningful elevation in the provision, and I think part of that clearly has to do with your consumer focus. But you also talked about the qualitative piece of it and the energy piece of it. How do you want us to think of maybe the puts and takes of the drivers? And I don't know if you'd take a stab at elevated provisioning for us.

Yes. It's a great question and it's appropriate, given the comments I made in my prepared remarks. I'm not going to give very specific guidance here other than to say, I think there's -- we do expect, as we communicated previously, continued elevated charge-offs in the oil and gas and energy book. The recent -- the long-term pressure we've seen on natural gas prices and compounded with the recent pressure from the oil price shock that we've seen will impact that portfolio, and we'll see those elevated levels. I think on provision, more broadly, we're continuing to work through what the outlook for provision is for the first quarter. And working through the CECL methodology, it's a somewhat pro-cyclical methodology and really based on 2 things, what are the projection scenarios incorporating, and it's important to note that those come out with somewhat of a lag. So at this point, the scenario -- the last scenario that we and others who use Moody's to produce those scenarios are using this from January. The other key factor is what the weighting on the scenarios is. And so I do expect that as the scenarios continue to unfold and incorporate new information during 2020, we will see them picking up more of the economic concerns and uncertainty that we're seeing now as we stand here in the middle of March. And that will drive elevated provision levels. The degree to which that goes, we really need to look at. And to some degree, I'll just close on -- you touched on qualitative. We think really carefully about what the CECL methodology is projecting in terms of provisions. Remember that it's a loan-by-loan methodology. It's extremely rigorous. But as I mentioned, sometimes the scenarios don't incorporate all the factors that we would think about on a loan-by-loan basis or are somewhat more delayed in picking up what's happening right now. So that's the purpose of the qualitative reserve is to make sure that we're properly reserved in light of some of those limitations of the model. And we're actively working through it right now. I do expect elevated provision levels. The degree to which that's going to happen is still to be determined.

Okay, fair enough. And we just have about a minute left. So speed-dating, speed-talking. But a little more optimism from your buyback, from an investor point of view, I guess, optimism, meaning you repurchase more. Anything you can do for the next CCAR cycle to prepare yourself to maybe get a little bit more aggressive on the repurchase plan?

No, it's really too early to say where 2020 CCAR is going to land. We're just in the depth of the modeling process right now. Some of the guidance in terms of how that process will work and what the discretion is left to banks like us to manage our capital uses going forward has improved and is more flexible, which we support. So too early to say. I don't expect a major change in our posture in terms of our payout philosophy, but we'll continue to monitor, certainly, 2020 very carefully, as I mentioned in my comments.

Okay, great. And just one thing for those listening before we close it out. Next session for the webcast is Mark Calabria who heads FHFA, which oversees Fannie and Freddie. So I want to make people aware of that. And then to close the session with Huntington, just thank you so much, Zack and Mark and your team, for the time today. We appreciate all the work you put into the update in the presentation, and thank you for your time.

Thanks, Jon. Appreciate it. Thanks, everybody.