Huntington Bancshares Incorporated (HBAN) Earnings Call Transcript & Summary

All right. Good morning, everyone. I'm Ken Zerbe, the mid-cap banks analyst at Morgan Stanley. I just wanted to welcome you to our 2020 Morgan Stanley Financials Conference. Before we begin, I do need to tell you that for important disclosures, please see Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. All right. So our next panel that we have today is Huntington. With us from Huntington, we have Zach Wasserman, the CFO; and Rich Pohle, Chief Credit Officer. So I'm very excited to have both of you with us today. [Operator Instructions] All right. So I think Zach and Rich may have a few opening remarks. I'll kick it over to them first. And then afterwards, we'll go into Q&A. So Zach, Rich?

Thanks, Ken, and this is Zach. Thank you all for joining us today on the webcast and for your continued interest in and support of Huntington. I'm joined today, as Ken mentioned, by our Chief Credit Officer, Rich Pohle; and our Director of Investor Relations, Mark Muth. Before we get started, let's turn to Slide 2. 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, I would instead provide focused remarks on our current priorities and insights into what we're seeing from trends in our business and from discussions with our customers in the second quarter, then I'll turn it over to Ken for Q&A. So starting on Slide 3. Our current priorities revolve around a continuation of our strategic plan, focused on delivering top-tier performance and superior customer experience. We continue to prioritize driving organic revenue growth across all of our business segments. Our digital and technology strategy and continued investment in these areas are helping fuel engagement and growth in our businesses. As discussed on the Q1 earnings call, we have begun a rigorous expense management plan. We've taken action to reduce near-term marketing and curtail nonessential consulting and outside services expenses. We're already seeing benefit from these actions, along with the dramatic reduction in travel and entertainment spending. We're accelerating a long-term structural and organizational expense reduction programs, given our outlook for a more gradual economic recovery. We will not be providing details, at this time, regarding the ultimate scale or timing of these expense actions, but know, we're taking decisive measures. Finally, maintaining a strong balance sheet remains a key priority for the bank. In May, we issued $500 million of preferred equity at a very attractive fixed rate, providing the bank with additional capital and funding optionality in the future. Now let's turn to Slide 4 to provide a quick update on the Paycheck Protection Program and forbearance activity. We recognize this is a pandemic -- is a health crisis, first and foremost, but it has also created economic -- enormous economic challenges for businesses. In just a short period of time, the bank mobilized to help small businesses and commercial customers access the Small Business Administration Paycheck Protection Program. I'm pleased to say that we have processed almost 35,000 loans with a loan volume of more than $6 billion, and we continue to close more PPP loans each day. The bottom of the slide provides additional details around forbearance activity by portfolio as of the end of May. We're working through the first wave of deferral maturities and are generally pleased with the condition of both our consumer and commercial portfolios at this point. One area that I would like to provide more clarity on is the curtailments in our auto floor plan business. These curtailments allowed our dealers extended time, typically 90 days, for vehicles to remain on their lots before principal adjustments or paydowns kicked in. We mentioned in April that roughly $2.7 billion of floor plan facilities had some level of curtailment associated with them. However, the $2.7 billion figure is a bit misleading as the actual curtailments only apply to $184 million of the vehicles with those outstanding total facilities. We remain very comfortable with this portfolio as this was the best-performing portfolio in our stress tests, and we are seeing early signs of a rebound in auto sales is occurring. Slide 5 provides an update reflecting May 31 balances, including PPP loans, for the areas that have been hardest hit by COVID-19. We have recently completed deep dives into nearly all of these portfolios and are comfortable with our team's assessment of the current situation. Huntington's enterprise risk management is a strength of the company and is guiding the actions we're taking. Quarter-to-date, we have sold nearly $100 million of oil and gas loans and continue to actively manage the noncore exposure in this portfolio lower. We also sold $327 million of ABS and REIT securities, including some in high-impact sectors, including the travel and residential real estate, in response to deterioration in economic conditions. This generated a loss of $1 million, which will impact the second quarter results. Let's turn to Slide 6 to discuss some recent trends. As you can see on the top-left chart, our commercial loan balances have increased dramatically over the past 2 months. First, as a result of increased commercial line draws and then from the Paycheck Protection Program. If you look at it excluding the PPP balances, commercial loan balances are now more in line with the level as of the beginning of March as much of the line draws have paid down. Deposit balances have grown nearly commensurate with the increase in the commercial loan book. The bottom charts illustrate 2 of the key drivers of fee income for the quarter. As you can see, salable mortgage origination volume was exceptionally strong in April and May, which will provide a fee income benefit for the second quarter. We have also highlighted the recovery in year-over-year debit card volumes and transactions since the lows at the end of the first quarter, which bodes well for processing fee income going forward. Turning to Slide 7, we will provide insight on the second quarter. We expect approximately 6% average loan growth over the first quarter on a quarter-to-quarter basis. Commercial loan growth is expected to be greater than 10%, driven by PPP balance growth and the dynamic of the COVID-related commercial line draws, which we highlighted on the previous slide. Consumer loans are expected to be flat to down 1% as growth in residential mortgage and RV/Marine is offset by home equity and indirect auto runoff. This growth is mostly in line with what we were expecting and discussed on the first quarter call. I would note that we are starting to see businesses begin to open back up in many of our regions. It is still early, but our commercial pipelines have rebounded more quickly than we expected in June, providing reason for increased optimism for the second half of the year. We expect average deposits to increase 9% to 10% linked quarter. The inflows from government stimulus programs have remained on the balance sheet through the end of May. We're also seeing stable production and reduced attrition so far this quarter. Deposit growth and retention have exceeded what we expected at quarter end. We expect total revenue to be nearly flat versus the first quarter, with net interest income coming in roughly flat as well as NIM compression is offset by higher-earning assets. Fee income projects to be in line with the first quarter as COVID and market-related fee income declines offset strong mortgage activity. Revenue growth is looking to be stronger for the first -- for the quarter than we announced on the first quarter call. We expect noninterest expenses to increase approximately 5% on a sequential basis, driven primarily by the seasonal increase in compensation expense related to the annual grant of long-term incentives and annual merit increases, partially offset by our expense reduction actions. This is modestly better than prior guidance. On a year-over-year basis, expenses will be lower by approximately 2%. Finally, the most uncertain item in the earnings outlook is credit provisioning. We're currently expecting net charge-offs in the second quarter to be near the high end of our average through the cycle target range of 35 to 55 basis points, which is unchanged from our prior guidance. This is reflective of the ongoing pressure in the oil and gas portfolio, including the loan sales in that portfolio as well as the broader economic considerations. Fundamentally, our credit remains sound. However, the economic outlook has deteriorated since quarter end and remains highly uncertain. This will result in elevated provisioning and additional reserve building in the second quarter and most likely for the next few quarters. It's much too early to estimate the ultimate size of the additional reserve build, but you should expect us to remain proactive in our approach to credit risk management. I will now turn to Slide 8 for some closing comments. You have seen this slide many times before, so I will not go through the details, just to note that our message has not changed. I will now close by highlighting a few last key messages. We continue to see sustained traction on our long-term strategic growth plans. We're focused on what we can control, driving prudent organic growth and executing our expense management plan. Our balance sheet is strong, and our capital priorities have not changed, including supporting our dividend, rebuilding capital from the impact of the CECL implementation. We're operating from a posture of strength, proactivity 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 Ken to begin the fireside Q&A section. Ken?

Great. Thanks, I appreciate the remarks. I guess why don't we just start off a little bit in terms of your updated guidance? I guess a few different things. So clearly, your deposit growth was very strong, certainly stronger than what you had expected at the end of the quarter, which is consistent with what we've seen from several other banks in the quarter. Is that driven -- I mean, obviously, PPP has a big part of that. I totally get that, and you mentioned that in the slide. Is there -- can you talk about other areas that are -- that -- where you're seeing sort of outsized deposit growth? But also at the same time, how sustainable is that growth? I would imagine PPP is fairly transitory, but there's probably other growth in deposits outside of PPP.

Yes. Thanks for the question, and it's a good one. And it is -- deposits are, in fact, performing considerably better than we had projected at the end of the first quarter and now as we get into the second quarter. And I think what we're seeing at this point is a number of levers performing better. Clearly, there's the PPP dynamic that you mentioned and withdrawals coming out of PPP are somewhat slower than we would initially have expected, although at some point, those will accelerate likely. But also we're seeing the stimulus program funds be held in customer deposit accounts much longer than we had originally expected. And at that -- at this point, we're not seeing really any material change in that amount being held, and so that looks to be more sustainable going forward. And the last thing I would say is we're seeing very low levels of attrition, so much lower than we would typically and historically have seen. And production is stable and beginning to accelerate again now that the economies are reopening, branch locations are reopening, et cetera. And I would say we're also seeing very substantially higher online and mobile production of new deposits. So I think the deposit trend is somewhat temporary from PPP, but there's also a number of factors that likely will continue for a long period of time during 2020. The outlook remains uncertain, and we'll watch it carefully. But at this point, we're feeling pretty good about the amount of liquidity and deposits that we're gathering.

As well you should, certainly. Next question, just in terms of NIM, same Slide 7 that you have. You mentioned that the NIM compression's offset by higher-earning assets from an NII standpoint. Can you just quantify or talk a little bit about more of that NIM compression? And the reason I ask is because we just had, let's say, one of your other Ohio-based peers come out with sort of almost shockingly severe NIM compression due to the excess deposit growth because they're keeping everything in cash. How are you guys investing the excess deposits? I mean could we see NIM fall sharply? Or -- I would love your thoughts on that.

Yes. No. Thanks for the question. Let me expand a little more and provide some facts. On an underlying run rate basis, and I'll define what I mean by that in a minute. But on an underlying run rate basis, the -- we expect modest incremental pressure over Q2. On a reported basis, we expect about 20 basis points reduction quarter-to-quarter from the Q1 level. Just remember, Q1 was 314 basis points. So that 20 basis points would take us down to just under 300 basis points or 297, something like that roughly for Q2. About 8 basis points of that 20 basis points is from the derivative ineffectiveness mark. So we mentioned in the Q1 earnings that we got about 4 basis points positive impact from that in Q1. So far in Q2, we're seeing the opposite, roughly 4 basis points negative impact. So that's an 8 basis point quarter-to-quarter delta. The prior guidance had been, when you strip that out of Q1 and you looked at the 310 underlying run rate, we were expecting to see roughly 7 to 10 basis points of compression into Q2. Now we're seeing roughly 10 to 12 basis points. So it's about 4 basis points additional compression, roughly half and half, 2 basis points from continued yield curve decline. Just to give you a sense, in May, the 1-month LIBOR was down 6 basis points; the 2-year LIBOR was down 8 basis points. So we're seeing that slowly come through into our NIM by around 2 basis points additional pressure in Q2. And then the remaining 2 basis points is from the increased liquidity on the sheet that you mentioned in your question, Ken. We are seeing those high levels of deposits. And just how quickly they came on to the sheet is going to drag down the NIM a little bit temporarily here in Q2.

Got it. And are you investing those in -- or keeping those in cash? Or are you putting those to work into other types of short-term securities?

Really, keeping them in cash and deploying them in loans at this point. We're not repurchasing additional securities at this time.

Got it. Okay. Perfect. And then just also, based on your comments that you mentioned, I think you said that we should expect continued reserve build. I think it was for the next several quarters. Just given the uncertainty in the environment, can you just reconcile that versus sort of the broader CECL accounting framework? Which, from what I understand, CECL says you should really front-end load most your reserve build based on sort of changes in the economic environment. When we get to, like, say, second half, I -- which I know it's impossible to know, like what reserves are going to be in second half. But if the economy does start to stabilize or even improve, help us reconcile why, say, reserve build or provision expense would be higher -- or still continue to be elevated in the second half versus being something much, much lower, given that you've already sort of built your reserve up?

Yes. Ken, I'll take that. This is Rich. I mean I think if we see that, certainly, that will factor into whatever the provision we have in the back quarter. I mean the scenarios that we're working off of now, the May scenario for Moody's and even the June scenario that just came out and we've got the highlights from, really don't show that. So to the extent that we do see improved economic scenarios, we will certainly incorporate that into the provision in the back half of the year, and that will frame whether or not we're building or releasing reserves at that point. Too early to tell, I guess, is the short answer.

All right. Understood. All right. I guess maybe staying with credit then. I know you have a slide in your deck talking about sort of the at-risk exposures where the industries are impacted by COVID. Can you just talk about how those industries are trending versus expectations? And is there any that are worse or better than what you had thought, say, a month or 2 ago?

Sure. Yes. So on Slide 5, the first thing I'll point out is that there's $2.8 billion of PPP loans that are in these numbers that weren't in there in March. So if you're looking at the balances and saying, why did these numbers go up? It's primarily PPP. We're not adding to these sectors right now. So as you can imagine, we've had a lot of eyes on these portfolios over the last several weeks. We are going through weekly portfolio reviews of these sectors. And so we have touched a number of these more than once over that period of time. And so I would say that generally speaking, as Zach mentioned, we're very satisfied with the position of the book right now. Our hospitality exposure is concentrated in a handful of names. I'd say 70% of our CRE hospitality exposure is in 5 sponsor groups. And we are very comfortable with these sponsors. We've been through the last downturn with many of them. They performed very well. We've had extensive conversations with them and feel that they have the liquidity, the capital and the -- other levers that they can pull to kind of work through this with us. Now certainly, the hospitality sector is going to be a longer road back to where it was pre-COVID than others. I mean we're thinking it's an 18-month-or-so return to breakeven, and we're prepared to work with the borrowers here. But we do like the positioning of the book. About half of it is Marriott and Hilton-flagged properties. So you also get the additional support from the flags in that instance. So that's one we're keeping an eye on. We do know it's going to be a longer road back, but we like the position of the book heading into it. As it relates to the retail side of things in commercial real estate, that's a more diversified group of sponsors. A fair number of them took 90-day deferrals, about 75% of the book. But I think also, as we went through it and looked at the makeup of that book, 40% of it is anchored by value stores, 16% by grocery and another 14% in high-grade single-name tenant. So again, 70% of that book, we feel very good about just by the fundamentals of the property type and the tenant base. And we do have, I would say, fairly limited exposures to Pier 1, Macy's, JCPenney and others that have announced widespread store closings. The health care services piece of things, the elective surgeries are coming back. There is a tremendous backlog of those surgeries that we'll need to get worked through. The dentist offices are opening up, and conversations with those practices -- they will be going full bore for weeks to catch up to what they've got. So in a lot of instances, those are really just deferrals of surgeries, those surgeries that still need to happen, and people still need to go to the dentist. So it will -- we expect that, that book will bounce back as well. Transportation, for the most part, has continued to perform well. We didn't see a very sharp decline there, and we expect that there'll be continued improvement there as well. We can talk more about energy. I think we can certainly go deeper there that we remain challenged with our view of the fundamentals there, and that hasn't changed. So I would say that's one that we continue to have concerns about. But by and large, the rest of the book that we called out here on Page 5, we feel very good about. And we haven't come across anything -- other sectors so that we're overly concerned about it at this point. And as it points out on Slide 5, very little exposure -- the airline exposure we have is iPads to pilots and flight attendants, and it's fairly modest exposure. So nothing in big jets and nothing with casino, student loans or Term Loan B, leveraged loans or oilfield services. So some of the high-risk sectors that are out there, we are not in.

All right. Perfect. That definitely helps. I guess maybe energy, just since you did mention it. I know energy -- it's such a small part of your total loan portfolio, but we've seen -- I'm going to say, just looking at the price of oil, like such a rebound over the last month or so just in terms of oil price. Does that change your view? I mean you have a 20% reserve against your energy portfolio. Like, does that change how you're thinking about ultimate loss content on this portfolio if OPEC+ continues to stabilize prices from here?

Well, I think you have to look at where the price level rebounded from. I mean it was -- there was a month there where it was negative. And it's bounced back up to the 30s, which we feel good about, but it really doesn't change our view long term. I mean the short-term disruption that we saw in prices, people were hedged 70%, 80% through 2020. So the -- it was big headline news, but for the producers, they were pretty well hedged through that. And so the short-term piece of it is not the concern. It's really the longer-term fundamentals that we see here, particularly in natural gas. I mean we feel better about oil than natural gas. And if you go out and you look at the price strip out into 2021 and 2022, you're still in the mid-2s for gas. And at that level, it's hard to get investment into that space and quite honestly there's not -- the producers, at that price level, aren't generating an awful lot of cash flow. And so that's the concern we have because we don't see the long-term supply/demand imbalance shifting over the course of the next couple of years, which is when a lot of these hedges start to roll off. And if you then become exposed to market prices in the $2 range, that -- we don't think that that's fundamentally good for the industry. So that's the concern that we have. So the 20% reserve that we've got at the end of the second quarter, we are mostly through the spring borrowing base redeterminations, we've got a handful left. We'll review those results versus the current reserve at quarter end and make a determination there as to where we think we need to be. But I would say, we split the book into a core/noncore portfolio as well, and the focus is on making sure that we can manage that noncore piece of it down and make sure that we're reserved appropriately for what we think the losses in this book might still be.

All right. In terms of the corporate line drawdowns, I think you had mentioned that you're seeing faster drawdowns or that a lot of the drawdowns have already repaid so far, which certainly faster than what we had expected. Does that -- I know you addressed the credit quality piece in general about the at-risk industries, but from the rest of the portfolio, does the paydowns imply a stronger customer? Or is the quality of customer the same, just simply there's less fear in the market?

I think it's the latter, Ken. We see it as a really good sign actually that our corporate customers -- I think these line draws were essentially from really high-quality names who were, I think, prudently getting cash onto their balance sheet to -- forced all threats to the economy that were very uncertain. And now that their outlook has resolved and they're more confident, they're paying them back, I think, is what we're seeing. The other factor that I think is contributing, to some degree, is that the capital markets are functioning more normally and the normal sources of funding for these companies are coming online. So we see it generally as a really good thing. They're essentially entirely repaid at this point. And I think I would just -- maybe I'll just tack on to say, as I noted in the prepared remarks, we are starting to see commercial pipelines rebuilt. So I think generally, the outlook is -- it's still early days. We'll be limited in scope and prudent about new loan production in the commercial side. But we're open for business, and we are seeing pipeline start to rebuild here. So I think the outlook for regrowth here in the second half in commercial is looking more favorable than I would have said a few days ago.

No, that's great. That's awesome. I guess switching gears, just in terms of expenses, it sounds like you guys are taking expense management pretty seriously given the environment, which I certainly think is a great idea. We've had, I'm going to say a month, 1.5 months or so since earnings when you first introduced it. Can you just talk about like how things have changed, where you stand with sort of some of your expense cut programs versus your prior expectations?

Yes. Sure. So I mean I think generally, our expense management program is exceeding our expectations thus far into the year in Q2. I think to some degree, we're benefiting both from the last year, the 2019 expense reduction program that we put in place in the fourth quarter just in anticipation of possible economic weakness in 2020, certainly not foreseeing this one, but just the possibility. And -- but now even more so, the new program that we're putting in place. I think as we've talked about a couple of times, the program we're working on now has 4 elements, all of which have a somewhat different timing to them. So the most immediate levers that we could pull were the discretionary expenses around travel and entertainment, outside services, things of that nature. That's happening very quickly, and we're seeing very material and positive expense management from that. The second one was around investments where we're prudently relooking at marketing and phasing marketing. Just given, frankly, the macroeconomic demand situation, that's a smart call. And so that's benefiting from that in the second quarter here. One thing I would note in the investment area is we're not reducing our technology investments at all, in fact, increasing them as that's becoming ever more important, as you might imagine. The 2 parts that were -- that are longer term are around our structural expenses, i.e., real estate, the REIT -- the real estate footprint, which, given everything we're seeing with COVID and virtual work, presents some material opportunities to us, important opportunities. And so that one has actually started to increase and be larger than we would have originally expected, say, a quarter ago. And the last one is around the org, where we continue to look at the pace of hiring, the structure of the org and where we want to exit 2020 and 2021. Still work to -- more work to do on that, and I'm not going to go into the details around that at this time. But I think generally, I would say, if I sort of pull back and try to answer the spirit of your question, which was how has it changed, I think we're seeing faster impact into Q2 than we had expected. But broadly, the expectations or goals for the program are not materially changing. And it's really designed to drive momentum out of '20 and into '22 -- '21 with the goal toward managing our efficiency and ultimately, creating investment capacity that we intend to plow back into strategic growth initiatives and technology. So we'll communicate more in the coming events that we have, but that's sort of the spirit of it now.

Great. And any chance you might want to quantify any of that impact on this public forum that we have?

I appreciate you asking that, Ken. I think the time is not right for us to do that right now, but we will [ soon ].

Understood. All right. Well, we are out of time. I definitely want to thank both of you, Zach and Rich, for attending the Morgan Stanley Financials Conference. So thank you so much for being here. And I appreciate everyone who's on the line listening in on the presentation. So thank you much, everyone. Have a good day.

Thanks, everybody. Thanks, Ken.