Huntington Bancshares Incorporated (HBAN) Earnings Call Transcript & Summary

Good morning, everyone. I think we're live. Hopefully, we're live. This is Brian Foran from Autonomous. I'm the regional bank and credit card analyst. Delighted to have Huntington with us here this morning. Both Rich Porrello, who runs the Auto Finance business as well as several related portfolios, such as marine and RV lending; as well as Mark Muth, who is the Director of Investor Relations. They are joining us from the headquarters in Columbus. They're going to make a couple of opening remarks, and then we'll jump into a fireside chat and leave plenty of room for investor Q&A. Just a couple of logistical things. In terms of the Q&A, you should, if you're in the conference website, have the ability to see pigeonhole. I believe it's on the left-hand side of your screen, on one of the sides. Just a little system to enter questions as well as vote on them, so you can upload other people's questions if you like. If you're having any trouble get into it, you can also go via your web browser to pigeonhole.at, so not .com, .at, pigeonhole.at. When you're prompted for passcode, just enter ODC2020, O-D-C 2020, and it should get you to a list of companies and you could just click on Huntington and go from there. On the other side of your screen, you've got a Procensus link. That's a little poll to offer some views on the company and the stock, and we encourage you to do that as well. So first, Rich, I want to thank you for taking the time today. And maybe before we jump into questions, I'll turn the stage over to you to give a couple of opening remarks.

Thanks, Brian, and good morning, everyone. And I appreciate your interest in Huntington. For context on me, I've been with Huntington for 33 years and have held virtually every role in the Auto Finance business. I've been in my current role running the day-to-day of the business since Q4 of 2010. Huntington's auto finance business is relationship focused. Our local market delivery of a complete set of banking products for dealers in one infrastructure is a differentiator from every other lender, captive, bank, independent or credit union in our 23-state footprint. We are the only super-prime lender to have a local presence in our markets with 11 regional centers, where our region managers, underwriters, commercial and indirect relationship managers focus on local delivery of our products and services. Being local matters to our customers. While the industry was challenged in 2010, we began an expansion opening 5 new regional offices, providing credit to both dealers and consumers when they needed it most. We have a 70-plus year uninterrupted history of providing franchise dealers financing for inventory, real estate, treasury management services and indirect auto loans. We have deep relationships with our dealers. Our colleagues, like me, have a long average tenure with Huntington. Our differentiated model attracts both colleagues and customers. On the commercial side of our business, Huntington has a relationship with over 450 franchise dealers. We provide an entire banking suite, including floorplan and dealership real estate lending for these dealerships, dealers and their families advising and supporting generational changes. We provide financing for many of the top 50 dealer groups in the country. Our customers -- dealers are chosen very carefully and, for the most part, provide their entire banking relationship to us, inclusive of a large share of indirect paper. These relationships have deep cross-sell. On the indirect side of our business, Huntington has a dominant position in our footprint with over 4,200 dealers. Again, we focus on a super-prime customer base with average FICO scores above 760. Our dealers want fast but consistent credit decisions. 70% of our indirect decisions are automated by our custom credit scorecard agent. Those decisions take 3 seconds or less. For the 30% of the decisions that are not automated, the scorecard makes a recommendation to one of our local underwriters, who approve or deny that request. These recommendations are rarely overridden. When a local underwriter does in fact override an application, it gets highly scrutinized by our quality control group. We also provide dealers with a sales tool, we call the grid, which provides a matrix of approvals on a single application to speed up the sales process for our dealers. Not only do we decision quickly, we also fund loans quickly, giving dealers their money the same day we receive a contract from them 65% of the time. We have also used technology to build highly efficient servicing and back office platforms. This technology, coupled with premium pricing that our strategy earns, continues to drive very strong risk-adjusted returns. Furthermore, we've been able to leverage Huntington's People-First, Digitally-Powered strategy to enhance our customers' experience. Slide 47 in the 4Q investor handout displays the markets we operate in. We have a dominant position in our traditional footprint and a growing presence in our markets. We're only in 23 states, yet we are the eighth largest bank lender for auto loans in the United States. Again, local matters. We hire colleagues with deep dealer relationships and industry experience that know the markets we serve. Our local market approach can't be underestimated to our value proposition. Relationships with dealers matter. More importantly, relationships with the right dealers matter most. Having the local market intel is critical. I've mentioned Huntington's custom scorecard and decision engine for our indirect auto lending a few times. These tools illustrate our ability to leverage our technology investments in both delivery and risk management. Our proprietary scorecard is a key differentiator and a driver for our success. The tool basically combines every aspect of the consumer loans application and credit Our scorecard contains data from the past 20 years' history and gives us the ability to both decision and price within seconds. FICO scores are important, but our scorecard is more of a differentiator and a driver to our success. Our card, or as I like to refer to as our secret sauce, has been critical in our ability to be consistent, efficient and effective in the marketplace. In 2016, as a part of the FirstMerit acquisition, we acquired the RV and Marine business. We hired a 20-year plus veteran -- industry veteran from a top 5 national RV/Marine lender to run our business. Then using the rigor of our auto business, we have grown that business to over $4 billion in outstandings, operating in 34 states. If you look at Slide 55, you will see that we are focused on even a higher FICO score in this business than our auto business. In fact, for the past 21 months, we've averaged an average FICO over 800. Being consistent for our partners -- to our customers and staying true to our low-risk culture in vehicle finance remain our top priorities. Brian, I'll pull up there and take your questions.

Thank you, Rich. I want to ask a couple of questions about the current environment. But before I do, just listening to you speak right now, 3 words have really stood out: Local, relationship and consistency. I think a lot of times, investors and analysts, I'll put myself in that bucket, can be tempting to think of the auto business almost as like an investment fund or a hedge fund. You're sitting there. The dealers putting the loan in Dealertrack, you're hitting a few buttons, you put a bid in on the loan and see if you win it against the other 5 guys. Can you give us a little bit more maybe on-the-ground color? How does that local relationship consistency really translate to better loan selection, better loan volume? On a day-to-day basis, how does that really differentiate you in the business?

Well, again, I'd say, dealers have long memories. Again, we've been in the business for a really long time. You mentioned that an application goes into Dealertrack and maybe they're 5 lenders, typically, what happens is there are 2 portals. There's Dealertrack and there's RouteOne, and the applications come to us. And in most cases, it gets sent to 2 or 3 banks. The application gets sent to 2 or 3 banks. If the captive has an incentivized program, they'll send it to the captive as well. But that application gets sent to us, and we'll make a decision, as I said, in -- 70% of the time, we'll make that decision in 3 seconds or less. So we're going to be -- most prominently, we're going to be first to respond to that decision. That helps us a lot. I mentioned the matrix that we call the grid. When we approve it, we give multiple ways for that consumer to consummate that transaction. Longer-term, more money down, less money down, which changes the rates, the finance manager or the dealer doesn't have to resubmit it. So the technology that we use and the relationships that we have has been a real differentiator for us to: a, get the application; and then, 2, fund it.

And coming back to the current environment, I think through the first 9 months, you're at about $4.5 billion of originations. Depending on where the fourth quarter shakes out, you'd probably be in line, maybe even slightly ahead of your best year ever. I believe that was back in 2017. And you've done it at a time when your FICOs -- your average FICOs in auto, they've always been very high. I mean, typically, they're around 760. But over the past few quarters, they've been running even higher, 770 or a little higher than that. So clearly, it's a super-prime business. You've made it even more super prime in the current environment. So what's enabled that success in 2020 specifically? How are you doing as much or even more volume at better credit standards?

Well, I would tell you. So we've always been consistent in this business, as I said. What's been different about 2020, we came out of the first quarter, you saw our first quarter results, they were really strong, and then the pandemic hit. And knowing that it's a large business for us, we stayed really consistent. So on the commercial side of our business, we look back and we said, okay, what are our dealers going to need? I mentioned we do business with 450 franchise dealers on the commercial side. We reached off every one of those dealers and said, what do you need from us? Do you need interest rate deferrals? Do you need your curtailment deferrals, principal deferrals, what do you need? And they really appreciated that from us. They appreciated the consistency that we provide. And for the most part, what we've seen -- very few took advantage of that. But when they did, we're basically through all the deferrals, dealers balance sheets are continuing to be robust with PPP as well as they've been incredibly profitable throughout the year. So they appreciated that approach, and they reward us with more paper. On the indirect side, at the same time, what we didn't do, Brian, is we didn't make dramatic changes for our program. We needed -- the dealers needed to know that we were there for them and the application flows continue as have the bookings through the second and third quarter. You saw the second quarter results, which are down, you can't make up for the shutdowns that occurred in many dealerships. But our results were really strong in the third quarter, and I remain optimistic in the fourth quarter.

Maybe talking about volumes, both for you and kind of across the market, thinking more broadly about just the environment for selling cars, I don't know what other people would have predicted, I certainly didn't predict the pandemic hit that some models would be sold out and have waiting lists and you'd have this surge in demand. I guess you can explain in hindsight, no one wants to take the subway anymore. But as you look -- you mentioned some optimism on the fourth quarter. As you look out to 2021 and beyond, would that optimism extend? Or how would you characterize the overall environment for new and used car sales as you see it?

I would say as I look out into '21, I think the market is going to continue to be strong. So -- but let's level set for a second. Year-to-date, the industry for 10 months is down 17%, but only 11.5% of that percent is down in retail sales. The fleet sales are down 39.3%, which really shouldn't surprise anybody, given the majority of that is made up of rental car companies. So the rental car companies in the fleets really aren't buying. Used sales through franchise dealers is only down 2%. And again, as I said earlier, the market really can't overcome the shutdowns in -- that came in the latter half of March and in April and in some states in May as well. But I see plenty of demand even without additional stimulus. But with more consumer stimulus, it will drive sales. I think it will drive sales. Consumers are sitting on more cash surplus than we've seen in a while. And I think that they want to upgrade. And to your point, many don't want to take public transportation today. So as I look at '21, I think '21 could look a lot like '19 from a SAAR perspective, high 16s, 17 million units, maybe.

Okay. As an owner of 2012 Honda Odyssey, I can tell you that several people in my family want to upgrade.

Well, Brian, let me just tell you that I think you should upgrade, and I know where you can finance.

The problem is I want to upgrade to a better Honda Odyssey and everyone else in the family wants something altogether different. Maybe sticking with the used car environment, you mentioned that's kind of the strongest place with franchise used dealer sales or used dealer sales through franchised dealers only down 2%. And the other thing that's been striking is just how strong used car prices are. And clearly, with the 770-plus FICO, you're not dealing with tons of default, so maybe used car prices aren't as big a credit input for you, but they do still matter and they also affect loan volumes just given the size of the loan. How are you thinking about puts and takes on used car prices? Has this been a permanent step change up? Is this a short-term phenomenon? How would you think about used car prices over the coming months and years?

Yes. It's a great question. So when the shutdowns occurred in March and in April, we actually step back and said, likely used car prices will increase because the manufacturing is shutting down and new production will slow. We clearly didn't see MMR, which we look at closely, which is the Manheim Market Report. We didn't see it going up to 163 from August -- in August, which was an all-time high. It dropped in April to 125. So back to your point, they're up 15% year-over-year. I think as I look at next year, they're going to normalize. I would suspect they'll normalize, come down from where they're at today. I looked at 2019. And in 2019, Manheim Market Report was about 138, which is still a really, really strong used car market. So I see it going down to sort of around that level and averaging there. But to your point, we are benefiting from a high used market today in our LGD, or loss given default. We see that. But our focus given that we focus on the high FICOs, it's really around frequency of default. So we haven't changed our scorecard to believe that these high used car values will be around forever. We know better than that. They always change. And again, I think as I look at '21, they'll come down, but still a really strong market.

And maybe going back to the new versus used dynamic, I think you saw a big spike up, obviously, in your used percentage. You mentioned the appendix slide you gave, which has great detail in the earnings deck. I forget the exact number, but maybe your used car went up to 60%, 65% of volume or something. As you think about that used versus new mix, do you think you're back to normal now? Are dealers restocked? Is there still some normalization to come? Historically, you've been close to 50-50, maybe weighted a little way one way or the other. Has that environment of used versus new now normalized?

Yes. So 2 points there. We are back to a more normalized level. But I would tell you, new inventory levels are still down almost 25%. Floorplan utilization is significantly down, and inventory levels won't likely normalize in the dealer world until sometime late in '21, as the manufacturers catch up. And on top of that, sales continue to be really robust. But the reason why we saw the Q2 change in mix to a higher used is because once the pandemic hit, you saw the captives really get aggressive on new car finance incentives. So for example, in April, new car finance incentives reached over $6,600, which was really high. So they focused on 84-month financing or 0%. Well, banks don't have that. So the captives -- for the vehicles that were sold in Q2, the captives drew a dominant share of that business, which caused us our mix on used to go up, which isn't unusual. Captives change with their programs, and we're obviously consistent and stay in the business. As inventory levels have dropped, the financing incentives are now down to around $4,000, a lot less. So now banks are financing more of the new cars than they were in Q2. So what I will tell you is we measure risk reward weekly, and we optimize accordingly. So fluctuation in this mix for us is not a huge concern. But I do think, over time, we'll normalize closer to the 50-50.

And maybe that's a nice segue to competition. I mean, one of the unique factors about auto to other lending, if you kind of have the banks that are 1/3 of the market, you've got credit unions that are 1/3 of the market, you got captives at 1/3 of the market in the prime space. Obviously, in subprime, you then get into finance companies, too. So it's very competitive. It's very diffused, a lot of different people. I think given that dynamic, I think a lot of people, including myself, have been surprised how well yields have held up, from the bank's perspective? How high that remains? What's your kind of outlook for loan pricing and competition overall? Is this kind of a stronger for longer story? Or was there some catch-up in terms of downward pressure to come?

Well, Brian, one thing we know for sure is that pricing is always changing. And you could always count on the captives adjusting and changing inventory levels. And they're there to move iron and they change based on they supply, and we saw the big change in Q2 as well. Small banks and credit unions come and go, and they really price for production, not always appropriately for risk-adjusted returns. Most don't have the technology to compete long term. When I look out, and for the most part, I've been saying this for a while, the larger players in our space have been really rational. And again, we look at pricing and risk-adjusted returns weekly. Each of our 23 markets have 1,000 pricing cells. So when you think about 1,000 pricing cells, you have Asia vehicle, you have different loan to values, you have custom score groups that I mentioned that our score sets spits out. And we have an optimization model -- a pricing optimization model that we run again and weekly to monitor this. So I would say this is another use of our technology that has differentiated Huntington in this space. And again, but I will say, as I said earlier, that the large players continue to be fairly rational. So there's always downward pressure, but we have to be focused on what's best for our shareholders.

And in some ways, I think in April, I probably would ask 7 credit questions by now. But in some ways, the lack of the question is a testament to what you've done. I mean, you're running a super-prime book. Losses are only running about 30 bps. They're only up 4 or 5 bps from 2019. One of the unique things you gave is vintage disclosure as well, delinquency 6, 9, 12 months in or maybe it's losses, I forget which. But you've always given that disclosure. It's very helpful. And we're really not seeing any upward pressure on losses even from the loans written in 4Q '19 or 1Q '20. So you've touched on it throughout your comments. But what else would you stress to investors? What has enabled you to stay at a pretty minimal level of losses even as unemployment basically hit 20% at one point?

Well, I would tell you, it's going to sound a little redundant, but I'll reiterate. So primarily, you really have to choose the right dealers. Choosing the right dealer to do business with is critically important. And that's why our local model matters so much. And then, of course, utilizing technology and consistent underwriting and pricing discipline to make sure adverse selection is avoided. You have to use the technology because, again, adverse selection can hurt you, and that's why you have to look at pricing and your credit metrics weekly. You mentioned unemployment, and unemployment is the one macroeconomic factor that is something that has downstream implications to our business. I remain confident, especially when you saw the 20% unemployment. And you saw our losses in a steady state. So I'm still very confident that our book will outperform, given all the reasons we've already discussed.

Let's talk about RV and Marine for a second. You mentioned post-FirstMerit, it's been a nice business for you, up to $4 billion. It's another place that demand has been surprising. I'm actually in the market for both a boat and a golf cart. So if anyone is selling, ideally in Northwestern Connecticut, please e-mail me or you can put it in pigeonhole, put your price and expectations in pigeonhole. But it's a place you've seen tremendous volume. You've seen 800 FICOs, as you mentioned. Can that hold up? Is that a new run rate for this business? Is it a temporary surge? How are you thinking about the outlook there?

Before I take your question, I'm going to have another commercial for us. So again, if you want to finance your boat, we're happy to finance that when you find one. We don't do golf carts, but boats we will finance. So consider us when you go to that dealership to buy your boat, but...

I'm pretty cheap at heart. So I'm hoping for a 20-year-old pontoon boat. But if my family gets -- convinces me to go big, you'll be my first call.

Okay. Yes. Again, this has been a growth engine for us. But -- and I do think that it will remain strong. This business is similar but different than the auto finance business. So if you think about the competitors in the auto finance business, we have a wide array of competitors across the spectrum. And in the super-prime space, we have multiple competitors. In RV/Marine, it's a much smaller group. So there are 5 or 6 really large competitors. And we are becoming a significant player in this space, now being in 34 states. It's very, very important that this business remains a low-risk business for us. And you mentioned the FICO stores, very important that we stay at a really high FICO. We are leveraging the auto finance platform and technology and in underwriting to grow this business. At the same time, you heard me mention, we've got a 20-plus year history with our scorecard in auto. We don't have that in RV/Marine, but we're building it. And we will have the same technology that we have in auto over time around the score card. But again, this business, as I said, a smaller competitive set. And at the same time, the dealers are probably a generation behind auto in technology and mainly being with the customer and how they interact with the customer. But I really believe that we will stay very focused and able to grow this business, and our technology will differentiate us even further there.

I'm going to jump in with one investor question. It kind of made me laugh because for years, I asked myself this question and now doing the shopping myself, I think I know the answer. Why would someone with an 800 FICO choose to finance an RV or a boat as opposed to just buying it in cash? So why give customers with 800 FICO?

Well, again, many of -- we're seeing more consumers want to preserve their cash than ever. At the same time, with the rate environment being what it is, the payments are relatively low with low interest rates, and it's a great opportunity to finance that transaction. And we do see many consumers taking advantage of paying cash, but we see more financing it simply because they're preserving capital.

As someone -- the first boat I looked at was a pontoon boat. It's very nice, but it's still a pontoon boat. I asked how much it was thinking the answer would be 20, 25, 30 and he said, last year, it would have been 55. But right now, I could sell it for 70. So when you get a $70,000 bill, a loan doesn't look so bad, all of a sudden. Before we open it up to a couple more investor questions, I want to go maybe a little bit different topic. You've been leading the auto business for some time now, as you mentioned. You gave a nice interview just before the pandemic in one of the trade magazines. And you talked about -- a little bit about leadership. Some of the lessons you learned working construction with your father, growing up. And one phrase you used is hearing, you have to work hard and you have to lead by example. Maybe talk a little bit about what that's meant to you over time. But also in particular, how that's translated to this current environment to the semi-virtual world we all live in? How have you continued to lead the auto business when Mark is probably the first person you've been in a room within a week?