Huntington Bancshares Incorporated (HBAN) Earnings Call Transcript & Summary

Okay. You guys can hear me now?

Yes. We can, yes, we can. How are we coming across to you? We can hear you. Yes.

Perfect. I can hear you just fine. Okay. I believe we are live, so why don't we go ahead and get started. So I'm Ken Zerbe, the mid-cap banks analyst here at Morgan Stanley. Very excited to have with us, Huntington is our next presentation. Our presenter, we have Steve Steinour, who's the Chairman, President and Chief Executive Officer. We also have Zach Wasserman, Chief Financial Officer. Before we begin, just wanted to make sure I have to read some important disclosures. Please see the Morgan Stanley research disclosures website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales rep. So Steve, Zach, thanks for being here today.

You're welcome.

Pleasure.

While we just jump right into sort of some broader issues. We do hear a lot in terms of technology about the bank spending a ton on technology and how important it is. And I know most banks have expanded their consumer-facing technology offerings this year given the pandemic, and obviously, you guys have as well. But is it a fair statement that most of the regional and larger banks have fairly similar technology offerings? Or do you actually think that you can truly differentiate yourself with your technology to say you're different, apart from peers?

Ken, thank you for hosting us today, along with NASDAQ and the Morgan Stanley team, first of all, and thanks to all who have joined. To come back to your question, most banks have many of the same core product offerings such as mobile deposit, bill pay Zelle, online account opening, et cetera. But our strategy has consistently been to build a differentiated proposition. And so we talk about that in the context of people first and digitally powered as a national bank. And on the tech side, we do that by differentiating the customer experience. So that's how we've got multiyear J.D. Power #1 s for regional bank. And we focus on 3 areas: point-of-sale capabilities to originate products. Engagement tools, and this is important to allow customers to more effectively self-service and manage their accounts. And then finally, taking advantage of data and analytics and some AI or machine learning, personalizing. So that we're creating curated and tailored experiences for our customers. We're trying to bring that all together in a very differentiated way. Now this pandemic, I think, has accelerated use of mobile and digital in the U.S. by several years. At least. We think that is a continuous trend now, not just a point in time momentary usage. So we've been accelerating our digital plans. And in that regard, our point-of-sale capabilities for consumer products are largely in line now as we come into the end of the year, whether it's home lending or other types of checking, savings, credit card products. We've listened to the customers, our customers, and have tried to meet their expectations or even facilitate the development of those expectations in terms of how we've personalized. So we've got a very sophisticated alerts platform that's been put in place. We call it Huntington Heads Up. And it's powered by pattern recognition and AI, and so it's meant to be proactive in terms of helping them via alerts manage their accounts. We've further gone forward with what we call Money Scout, and that's an automated capacity to transfer funds, again, looking out for our customers as we move forward. And then in just several months ago, we announced moving 24-Hour Grace, our award-winning consumer product to our business customers, a time of need and stress in the business environment, much like it was 10 years ago for consumers when we did that. And we also implemented what we call Safety Zone, a no fee for 50 -- up to $50 overdraft for all customers, businesses and consumers. These steps may appear minor, but they're very significant. They register heavily in terms of customers and what they like about us, and that helps to propel the brand. Now -- and so that's why I think we've had these J.D. Power awards multiyear on mobile banking as #1 and either a 1 or 2 on online. And I think this has heightened consumer switching preferences to us in a powerful way in our footprint at this point, but it lets us be very competitive with fintechs, large bank -- larger banks, et cetera. And it's clearly driving engagement. We see it in our stats. Our mobile log-ins are up 34%. digital deposits up significantly year-over-year, a series of metrics that show us that we're absolutely on the right track. Thanks for the question. Sorry for the long-winded answer.

No, that's great. That's what we want to know about. Zach, a question for you. We do hear a lot about the consumer facing technology. We really don't hear much about what banks are doing on the commercial side. What's Huntington doing with technology and the rest of the bank, like specifically, auto and commercial?

Yes. Thanks again, Ken, for the question and for hosting us. So we do talk a lot about the consumer side because it's something we're really proud of. The 3 big focus areas that sort of underlie what Steve just talked about in terms of our digital strategy, driving point-of-sale product origination capabilities for all of our products online, so critical now, clearly; creating new services and product features that drive engagement and deepen engagements and use; and then that personalization. The consumer business within Huntington set the template for that really incredibly effective development across all those 3 things, but behind the scenes, in a way that is incredible template for us to now leverage. So there's a best practice that we've built to drive that kind of development, out scale and out speed. But it's not the only place that we're doing it. So a couple of examples of other places that we've been doing development on the digital side for a while. For example, a vehicle finance, a really important business for us and one that's ripe for digitization. The last 18 months, we've been building tools to allow client onboarding and then payments and management of their account online. We're looking to roll out the final phase of that to customers in the first quarter of next year. Treasury management is another one, a great example in place where we've been investing a lot. The historical focus has been around process automation, payments and cyber capabilities. But what we're doing now is, as part of our strategic plan we've just completed, is roll out that best practice that we've seen consumer create a fully agile development methodology of deep partnerships between our business teams and our technology teams out into our other business units. And not only rolling that out, but also accelerating the amount of investments and the pace as we exit '20 and go into '21. So for example, in Business Banking, really capitalizing on the momentum that Steve just mentioned in terms of what business needs and the products that are going out to business, to drive even more digital capabilities. Treasury management is going to shift toward customer-facing tools and mobile tools. And commercial, something I am personally incredibly excited about, creating a capability to have digital-first onboarding. In the life line of a client, if you can get them to engage digitally from the outset, you can get them to then deepen their engagement and use of your digital tools so much more going forward. So that's going to be a critical, critical one. Our wealth business and advisory business is another place, we see a lot of opportunity to create tools to better enable client adviser interaction. So here are just some examples. But overall, if you take a step back, it's all about hearing what the clients and our customers want and really driving the kind of investments that ultimately go to increase acquisition, increase retention and drive revenue growth. That's ultimately the key of all of these initiatives.

It sounds like there's a lot to invest in. I'm sure you could probably spend a lot more in technology if you wanted to. Maybe a question is just how do you balance that technology spend with bottom line results?

Yes. I'll take this one. That is the key question, Ken, clearly. And our relationships and our capabilities broadly, including this technology capability, is our competitive source of strength. The way I think about it is it all starts with our long-term value creation goals. We know the model. We want our assets to grow faster than nominal GDP and have sustainable share gains. We want our fees to grow faster than spread. We want to have positive operating leverage where revenue is growing faster than expenses over time. We want stable credit and an on-average over time reduction in our share count and repurchases and then our dividend yield. All of that contributes to TSR and the shareholder return that we need to have above cost of capital. But importantly, in that function is expenses growing less than revenue growth. So that's the key. That's how we balance it. We need to have overall expenses grow less than revenue. But what's critical is then what are those investments within the expense base doing? When I say investments, I mean technology, marketing, select adds to personnel. And our goal over time is to hold the non-investment expenses very flat. So that we can grow the investment portion of the expense base at 3 to 4x the growth rate of the overall expense base. So that's ultimately the fuel. And then it comes down to the process, agonizing over every dollar of investments in technology and ultimately shifting the mix to innovation and business driving. And then lastly, just track, track, track the initiatives that we have to drive the return. So that's what we're doing every day. And I think that over time we're going to see that manifest itself into accelerating revenue growth as we get throughout this recovery here in '21 and '22.

Got it. All right, that totally makes sense. Maybe switching gears just a little bit, Zach. You -- this morning, you issued an 8-K saying that you purchased $5 billion of interest rate caps to protect capital. Can you just discuss how those work and what your interest rate expectations are?

Sure. So I appreciate the question. That was an important new piece of guidance that we put out. Essentially, we've talked for a long time about wanting to make sure that we are protected in the low for long interest rate environment and for interest rates falling, and our hedge portfolio was an incredibly constructive way to do that. As we stand today, we want to also make sure that we are protected against the possibility of rates rising, and they have modestly over the last a couple of months as we all know. And one of the implication -- the 2 big implications of rates rising clearly will be helpful for asset yields but will reduce the value of the securities book, and therefore, capital. And so that's the thing we want to sort of hedge against, buy some insurance against, hence, the entering into these caps. So we bought into about $5 billion notional value of caps. They're in a fairly well-laddered portfolio, starting -- so with average duration of around 7 years but extending all the way out to 10 years. So kind of within the 6 to 10 range with an average of 7. To give you a sense, the average strike of them is 98 basis points. The cost is relatively modest. We're talking about around $10 million annual cost of these caps, but the protection is very substantial. It could easily be 4 to 5x that protection to the extent that, that interest rates start to rise materially. So it's incredibly constructive for capital. The only thing that I would say in addition to what I've said already is these don't get hedge accounting treatment. So they're not -- the premiums -- and kind of they're marked every corridor. And so it will drive a little bit of modest NIM volatility quarter-to-quarter. It might be in the kind of single basis point range, we'll see as the marks come through. But taking a big step back, we think it's incredibly constructive insurance to buy at this point to the extent that the interest rates start to rise, and we want to protect the capital with them.

Zach, one of your strategies to keeping them relatively stable has been to focus on higher-yielding asset classes, whether it's small business, resi, ABL, quick leasing, or deemphasizing some of the lower-yielding products. Now from a bank investor standpoint, we always associate higher yield with higher credit risk. How is this -- or is this increasing credit risk across the bank?

Yes, short answer is no. We've operated with our aggregate moderate-to-low risk appetite for over a decade with no intention of changing that plan. I think by the way, I think it's important to note -- with respect to our long term plans, the goal is not NIM management in and of itself. Our goal, our objective function is revenue growth and return on capital. NIM is a key metric, and it's correlated with that, but it's not our objective function in and of itself. What we're doing is just tuning the model at the margin and ensuring the best long-term return within our credit underwriting standards. To give you a sense, in consumer lending, we're not changing our focus. We're still prime, super prime. These are low-risk customers, product lines we have today. We're just optimizing the production between the products to claw back a few basis points. In commercial, it's about dialing up at the margin, production in product lines like, for example, equipment leasing, asset-backed lending. These are low-risk businesses. Small business interestingly is one that we're also -- we're seeing a tremendous amount of market demand for us and great brand receptivity. And normally, you might think that, that's kind of further out on the risk curve. But in this case, these are SBA guarantee loans that we're winning and providing. And normally we might sell a portion of those loans that's equivalent to the guaranteed portion from the government, but in certain cases, now we'll opt to retain the whole loan on the balance sheet, again, to sort of manage and optimize the long-term NIM and return. So taking a step back, nothing shifts the overall credit posture at all. We're talking about incremental changes, and really, just the goal of tuning, to claw back basis points here, basis points there over the next several years.

All right. Perfect. Maybe switching over to credit. I wanted to ask Steve about how credit quality has been trending versus expectations. But obviously, in your 8-K that you issued this morning, you did update your new charge off guidance. I believe it's for -- to be at the higher end of your 35 to 55 basis point range in 2021. That's a lot lower than what we were expecting. I think we were looking for closer to 100 basis points. Maybe you can just wrap all this into sort of 1 big question. How has credit quality been trending? But also, what gives you the confidence that the losses or credit losses could be in that, let's just call it, much lower than expected range in 2021?

Well, as you know, we have been looking deeply at the portfolios consistently throughout the year. So every month for the higher risk and every quarter for essentially the book. And so we've had multiple reviews of this. We've seen, as you saw in the third quarter earnings announcement, a very positive trend in terms of credit quality. That is -- that trend is continuing now in the fourth quarter. And we expect that will continue as the recovery continues. We've been bullish about the recovery now for a couple of quarters, and we think it continues. There'll be some choppiness, particularly with the COVID ramp up that we're experiencing now. So the first quarter could be a little uglier than the rest of the year. But the second half of next year, we think, is a lot better with the vaccines that are available than the first half. And we think we've got a trend line to establish now. The only caveat, we flagged in the third quarter, we'll continue to -- is with our SBA portfolio that has had 6 months of support from the SBA in terms of P&I payments as those small businesses at those companies come off of that level of support. We expect higher delinquency, ultimately higher loss. We're not seeing things at the moment that are alarming, but we do expect that there will be a bit of a bubble that will come through from that book as a consequence of the subsidy that otherwise might have been recognized earlier. So the positive outlook on the economy and then the strength of the analytics that we've been pursuing now for quarters create the optimism about next year and the performance next year.

That's great. It's great to hear. It's certainly, like I said, much better than our expectations and certainly better than the Street's. Maybe just a nuanced question, Zach, that I always -- we hear about COVID cases rising across the country or accelerating. Does that -- as we see that spike up in cases, like, is that sort of acceleration in cases already built into your CECL reserves? Or is there any risk that sort of the near-term economic impact of that spike in cases could actually lead to higher reserves, at least for the next quarter or 2?

Yes. It's a great question. It's certainly apropos of the environment we're in right now. Look, I think we continue to work through the analysis for CECL for Q4. And as Steve just mentioned, there are some countervailing forces. Clearly, the near term in Q4 is more choppy than we expected. The virus trending higher. The various business closures and curtailments in certain sectors like travel, dining, retail, in particular, seeing lower consumer spending and that's an impact. And I would note, by the way, that the CECL scenario that we used in Q3 assumed additional government stimulus in the foreseeable future, which continues to be uncertain as we stand today. So that's the kind of watch out side. But on the other side, the longer-term outlook has actually improved. And the scenario, for example, from Moody's that we're using now to build our modeling as we continue to work through it in Q4 is actually better than the Moody's scenario for Q3. Most notably, considerable progress on COVID vaccines clearly. To give you a sense, we weren't able to share more detail earlier on some of the macro trends that we would want to share. But I think what we're seeing in our footprint is extremely positive macroeconomic trends and generally considerably better that we're seeing in the nation overall. For example, consumer spending now higher year-on-year than it was before, even though most of the nation is down, unemployment being better in all of our footprint states essentially than the national average, a lot of manufacturing rebound that benefits our footprint states. And so our outlook for the unemployment rate, for example, at the end of '21, is now 1.5 percentage points better than it was when we were doing modeling in Q3. So you've got these Tale of Two Cities. We'll have to work through it. It's a mixed bag. But I would say just pulling back from that, overall, we're comfortable with our reserve levels. I do not expect material build or release in the near term, and I think that's what sort of to some degree as well very much correlated with the guidance that we gave, where we did expect charge-offs for next year to be within our 35 to 55 basis point through the cycle range, but in the upper half of that range. Everything that we're seeing is pointing to that kind of stable trend.

Great. And now, Steve, you've been trimming branches pretty regularly for the last several years. How much more room is there to take out additional branches before density gets too thin? And if I could also add, along the same lines, like when everything is moving digital, how do you actually sort of maintain that branch awareness or brand awareness, I should say, given the branch closures?

So we have been religiously looking at our distribution. And as you've said, Ken, but we're still #1 branch here in Ohio and Michigan, even after the consolidations. If you roll the clock back to 2016 when we announced the FirstMerit acquisition, we've closed since then 263 branches. 131 were related to activities of FirstMerit, a small divestiture we did in Wisconsin and 100-plus branches that we -- that we've subsequently -- we closed at announcement and then subsequently another 130-plus over time. But we're sitting with #1 branch share. And we've got #1 mobile. We're seeing significant uptakes. So we would expect there'll be further opportunities to adjust the branch distribution as we go forward. We have a very strong brand. The strategy has always been to not be wide geographically but to have a significant share where we are and to leverage the brand that's been built, and we continue to invest in that. And we will continue to invest in the brand as we go forward. So we've got a very strong Net Promoter Score. We've got a switching preference that advantages us relative to others in a significant way. That's reflective of the brand strength. And I think the opportunities for us to further adjust distribution over time, along with the continued investment in mobile are clearly there. That will, in part, fuel some of the investment that we will be making in mobile and marketing and other things.

Great. And I guess in the interest of time, I have 1 last question. I guess, Steve, this 1 is for you. When you think about loan growth from here, what categories do you think could actually drive the strongest growth for Huntington for both near term and long term? And is there any sort of acceleration or deceleration? Like, how do you think about loan growth broadly given as we come out of pandemic?

Yes. We've tried to -- the asset side of the balance sheet, roughly balanced between consumer and commercial. So we do a lot with vehicle, as you know. We also do a lot with home lending. We're the largest mortgage lender in Ohio. We're 1 of the top ones in Michigan. We're top 10 home equity lender in the country, but it's only in our footprint. So there's a lot that's done on the home lending side as well. And those will continue. And we like this 50-50 balance, particularly in a year like this, where commercials pulled back a bit, utilizations are down meaningfully, et cetera, and the consumer side can drive it. On the commercial side, we've got a really good asset-based team. We've got a very strong equipment finance team. We do a lot in health care. So we have a -- we're a significant middle market lender. We have a number of engines that are performing very well for us and would expect that to continue. So we're sitting now with a pipeline in November that's greater than November a year ago of high probable closing. So the key then is when does utilization start to come back, we think it's leveled off in the fourth quarter. And as the economy improves, the utilization will be a tailwind, not a headwind going forward.

All right. Great. It's a very positive note to end off on. So Steve, Zach, I want to thank you very much for participating in the conference. Thank you very much.

Thank you.

Thank you. Happy holidays. Thank you,

Sure.