Huntington Bancshares Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 20, 2023

There are 14 speakers on the call.

Operator

Greetings. Welcome to the Huntington Bancshares Third Quarter Earnings Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded.

Operator

At this time, I would now like to turn the conference over to your host, Tim Sedabris, Director of Investor Relations.

Speaker 1

Thank you, operator. Welcome, everyone, and good morning. Copies of the slides we will be reviewing today can be found on the Investor Relations section of our website, www.hunnington.com. As a reminder, this call is being recorded and a replay will be available starting about 1 hour from the close of the call. Our presenters today are Steve Steinour, Chairman, President and CEO and Zach Wasserman, Chief Financial Officer.

Speaker 1

Rich Poley, Chief Credit Officer And Brennan Lawler, Deputy Chief Credit Officer, will join us for the Q and A. Earnings documents, which include our forward looking statements disclaimer and non GAAP information are available on the Investor Relations section of our website. With that, let me now turn it over to Steve.

Speaker 2

Thanks, Tim. Good morning, everyone, and welcome. Thank you for joining the call today. We're pleased to announce our Q3 results, which Zach will detail later. Our approach to both our colleagues and customers continues to be grounded in our purpose.

Speaker 2

Our colleagues again demonstrated that we make people's lives better, help businesses thrive and strengthen the communities we serve. Now on to Slide 4. There are 5 key messages we want to leave you with today. First, Huntington is extraordinarily well positioned to manage through the evolving landscape for banks. The near term environment includes higher for longer interest rates and uncertain economic outlook, expected new capital regulations as well as heightened regulatory requirements.

Speaker 2

Huntington operates in this dynamic period from a position of substantial strength. Our balance sheet and risk profile were intentionally built over more than a decade, explicitly for these times. Our market position, Digital leadership and momentum in core growth strategies put us in the top of the peer set. We intend to lean into this position of strength to drive incremental growth through existing and new capabilities. 2nd, we've managed top quartile CET1 inclusive of AOCI.

Speaker 2

We will continue to drive additional capital expansion for the remainder of this year and over the course of 2024. 3rd, we benefit from a cultivated granular deposit franchise and have delivered consistent core deposit growth. Our balanced deposit base forms the foundation of our robust liquidity framework and has been a driving factor in our well managed beta over the rate cycle today. 4th, credit quality remains strong across our portfolios, driven by our disciplined customer selection, underwriting and rigorous portfolio management. This approach is unwavering starting with our tone at the top as we maintain our aggregate moderate to low risk appetite.

Speaker 2

Finally, we remain intently focused on our core strategy. We are executing with discipline, while expanding with existing and new capabilities to support our long term growth. And very importantly, we are remaining steadfast and our commitment to drive operating efficiency over time with continued execution of proactive expense management programs. We expect the level of uncertainty in the near term and some level of higher expenses to manage through the realities of the current operating environment. However, these investments will also be accompanied by sustained revenue growth and the net result will be a Huntington that continues to be a strong regional bank with significant growth opportunities ahead.

Speaker 2

I will move us on to Slide 5 to further illustrate our position of strength. Our adjusted CET1 ratio is strong and near the top of the peer group. We intend to drive this ratio higher throughout this year and 2024. This plan extends our position of strength, supports continued execution of core growth strategies and puts us well ahead of the proposed Basel III endgame and other requirements. Deposit growth has also outperformed our peers by nearly 10 percentage points since the end of 2021.

Speaker 2

We've built one of the most granular deposit bases with a leading insured deposit percentage and we continue to drive the expansion of primary bank customer relationships. Our liquidity is best in class for coverage of uninsured deposits, representing nearly twice the level of peers, and we already meet the liquidity coverage ratio On an unmodified basis, credit metrics are also a differentiator for Huntington, with top quartile net charge offs compared to peers And our credit reserves are top tier. Our management team has a long track record of disciplined execution. For example, We were recently named the number one SBA lender nationally for the 6th consecutive year and we continue to expand the reach of this business and our support of access to capital For small businesses, interest rates continue on a path towards the higher for longer scenario, which we've been anticipating for some time. As rates remain higher, the potential for economic activity to be negatively impacted has increased.

Speaker 2

However, thus far in the cycle, overall, Our customers are effectively managing through it. We remain highly vigilant and are proactively managing all loan portfolios. Our top tier credit reserves and expanding capital support our approach to be front footed to take advantage of opportunities to win new customers and grow our businesses. Zack, over to you to provide more detail on our financial performance.

Speaker 3

Thanks, Steve, and good morning, everyone. Slide 6 provides highlights of our 3rd quarter results. We reported GAAP earnings per common share of $0.35 and adjusted EPS of $0.36 The quarter included $15,000,000 of notable items, which impacted EPS by $0.01 per common share. Return on tangible common equity or ROTCE came in at 19.5% for the quarter. Adjusted for notable items, ROTCE was 20%.

Speaker 3

Further adjusting for AOCI, underlying ROTCE was 15.3%. Average deposits grew during the quarter, increasing by $2,600,000,000 or 1.8%. Loan balances decreased by $561,000,000 or 1 half of 1 percent from Q2, driven both by seasonality and our continued optimization. Net interest income on a dollar basis expanded quarter over quarter, driven by a rising net interest margin. We continue to proactively manage expenses and have begun a new set of incremental actions in the Q3, including branch consolidation, Staffing efficiencies and corporate real estate consolidations.

Speaker 3

These actions, coupled with our ongoing long term efficiency programs, As well as the measures we implemented in Q1 of this year will help us drive rigorous baseline expense efficiency, while sustaining capacity for investments in the franchise. Credit quality remains strong with net charge offs of 24 basis points and allowance for credit losses of 1.96%. Return on capital was robust, driving capital accretion with reported CET1 now above 10%. Turning to Slide 7, as I noted, average loan balances decreased 1 half of 1 percent from Q2, driven primarily by lower commercial loan balances, which decreased by $1,200,000,000 or 1.7 percent from the prior quarter. On a year over year basis, average loans increased 3.3%, reflective of our intentional optimization efforts.

Speaker 3

Primary components of the commercial loan change included CRE balances, declined by $387,000,000 driven by paydowns. Distribution finance decreased $434,000,000 Due to normal seasonality with lower dealer inventory levels in the 3rd quarter before the expected inventory build in the 4th quarter, Asset finance decreased by $271,000,000 Auto Floorplan increased by $122,000,000 All other commercial categories net decreased as we continue to drive optimization towards the highest returns. In consumer, growth was led by residential mortgage and RV Marine, while auto loan balances declined for the quarter. Turning to Slide 8. As noted, we continued to deliver consistent deposit growth in the quarter.

Speaker 3

Average deposits increased by $2,600,000,000 or 1 point percent from the prior quarter. Turning to Slide 9, we saw sustained growth in deposit balances in the 3rd quarter, including sequential increases during July, August September, continuing the trend we have seen previously. Importantly, core deposits represented the entirety of the deposit growth for the quarter With broker deposits declining quarter over quarter. Turning to Slide 10, non interest bearing mix shift continues to track closely to our forecast With the deceleration of sequential changes that we would expect at this point in the rate cycle. The non interest bearing percentage decreased by 120 basis points from the Q2 and we continue to expect this mix shift to moderate and stabilize during 2024.

Speaker 3

On to Slide 11. For the quarter, net interest income increased by $22,000,000 or 1.6 percent to $1,379,000,000 driven by expanded net interest margin. We continued to benefit from our asset sensitivity and the expansion of margins that has occurred throughout the cycle, with net interest income growing at 9% CAGR over the past 2 years. Reconciling the change in NIM from Q2, We saw an increase of 9 basis points on a GAAP basis and an increase of 10 basis points on a core basis excluding accretion. The drivers of the higher NIM quarter over quarter were higher spread net of free funds, lower fed cash balances versus the prior quarter and higher FHLB stock dividends in the quarter.

Speaker 3

Interest rates rose during the quarter, particularly at the longer end And as we expected, that drove a net benefit to NIM. In addition, our optimization efforts across both loan growth and funding mix continue to perform very well. These factors resulted in the margin coming in better than we had expected when we shared our outlook in July. We continue to analyze multiple potential interest rate scenarios. The basis of our planning and guidance continues to be a central set of those scenarios that is bounded on the low end by the forward yield curve And at the high end by a scenario that projects rates stay higher for longer.

Speaker 3

The higher for longer scenario today assumes one additional rate increase in 2023, Flat Fed Funds through October of 'twenty four and ends 2024 approximately 75 basis points higher than the forward curve. With the move in rates higher, we now anticipate net interest margin for the Q4 to be around 305 basis points to 310 basis points. This is 5 to 10 basis points higher than the level we shared previously. Looking further out, our modeling continues to indicate 2024 NIM trending flat to higher from the Q4 'twenty three endpoint. Turning to Slide 12.

Speaker 3

Our cumulative deposit beta through Q3 was 37%, up 5 percentage points from the prior quarter, tracking closely to our expectations. Sequential increases in beta are slowing quarter over quarter as we have forecasted as the interest rate cycle nears or hits its peak.

Speaker 4

As we have noted in

Speaker 3

the past, where beta ultimately tops out will be a function of the end game for the rate cycle in terms of the level and timing of the peak, The duration of any extended pause before a decrease. Given the outlooks for possibly a higher peak and very likely a more extended pause than was the case 3 months ago, Our current outlook for deposit beta is to trend a few percentage points higher than our prior guidance of 40%. We will have to see how the rate environment plays out into 2024 to know with certainty. What is critical in our view is to ensure we continue to manage Both deposit and loan pricing exceptionally rigorously, drive asset yields higher, deliver solid incremental returns and deliver a better overall NIM from the higher for longer rate environment as a result. Turning to Slide 13 and expanding on my point on loan yields.

Speaker 3

The construct of our balance sheet is approximately half fully variable rate, 10% indirect auto, which is a shorter approximately 2 year duration fixed product, 10% in arms with a 5 year duration and the remainder of approximately 30% is longer durated fixed. This mix contributes to the asset sensitivity of our overall balance sheet and has helped us to benefit significantly from the current rate cycle. We are seeing solid increases in fixed asset portfolio yields. Given the higher for longer rate environment, We expect to continue to benefit from this fixed asset repricing going forward, supporting the higher NIM outlook. Turning to Slide 14.

Speaker 3

Our level of cash and securities was down slightly from the prior quarter as we lowered some of the elevated cash we've been holding in Q2. During Q3, we did not reinvest securities cash flows and the securities balance moved modestly lower as proceeds were held in cash given the attractive short term rates. We're managing the duration of the portfolio lower, continuing our management approach since 2021. Turning to Slide 15, our contingent and available liquidity continues to be robust at $91,000,000,000 and has grown quarter over quarter. At quarter end, this pool of available liquidity represented 204% of total uninsured deposits, a peer leading coverage.

Speaker 3

Turning to Slide 16. We continued to be dynamic in adding to our hedging program during the quarter. Our objectives remain twofold To protect capital in up rate scenarios and to protect NIM in down rate scenarios. The most substantive increase was in addition to our forward starting pay fixed swaptions strategy, which increased by $5,900,000,000 during the quarter to $15,500,000,000 total. This program is intended to protect capital from tail risk in substantive up rate scenarios and once again benefited us as rates moved higher in the quarter.

Speaker 3

We also added $2,000,000,000 in callers to support our NIM against longer term down rate scenarios. Moving on to Slide 17. GAAP non interest income increased by $14,000,000 or 2.8 percent to $509,000,000 for the 3rd quarter. Excluding the mark to market on the pay fixed swaptions, fees were relatively stable quarter over quarter. On an underlying basis compared to the 2nd quarter, We saw increases in deposit service charges, including higher payment related treasury management fees.

Speaker 3

This growth was largely offset by lower capital markets fees. Moving on to Slide 18. We're seeing encouraging and sustained underlying trends across our three areas of strategic focus for fee revenue growth. Capital Markets, which has grown by a 19% CAGR over the past 6 years, benefits from a broad set of capabilities bolstered by KapStone. While 2023 has certainly been a challenging environment for capital markets activities in both advisory and several credit driven products, Forward pipelines within advisory are solid and we continue to foresee this as a primary contributor to fee revenue growth over the moderate term.

Speaker 3

Our payments businesses represent one of the biggest opportunities for both relationship deepening and revenue growth across both treasury management and card categories. In Wealth Management, we see a great opportunity to increase the penetration of the offering across our customers, leveraging our number one ranking for trust as we grow advisory relationships and drive higher managed assets with recurring revenue streams. Moving on to Slide 19, on expenses. GAAP non interest expense increased by $40,000,000 and underlying core expenses increased by $25,000,000 As I mentioned, we incurred $15,000,000 of notable item expenses related to the staffing efficiency program and corporate real estate consolidations. Excluding these items, core expense growth compared to the prior quarter was driven by higher personnel, occupancy, Professional services and a set of smaller items within all other expenses.

Speaker 3

We have taken proactive actions throughout the year to support the low level of core underlying expense growth we have delivered. In the first half of the year, We executed on the voluntary retirement program, organizational realignment, moving from 4 revenue segments to 231 branch consolidations. Now in the Q3, we're taking another set of incremental actions. We are accelerating the implementation of our business process offshoring program And we're creating efficiencies throughout the organization with the goal of prioritizing resources toward the largest growth opportunities in the near term. We're also driving incremental saves in our corporate real estate footprint, as well as implementing another set of branch consolidations with 34 planned closures early next year.

Speaker 3

These actions demonstrate our commitment to disciplined expense management and will support the continued investment into critical areas of the company to drive long term value. As we manage expenses, we're balancing Both short term investment and revenue growth with the longer term opportunities we know are in front of us. Slide 20 recaps our capital position. Reported Common Equity Tier 1 increased to 10.1% and has increased sequentially for 4 quarters. OCI impacts to common equity Tier 1 resulted in an adjusted CET1 ratio of 8%.

Speaker 3

Our capital management strategy will result in expanding capital while maintaining our top priority to fund high return loan growth. We're actively managing adjusted CET1 inclusive of AOCI and expect to drive that ratio higher over the course of 2024. On Slide 21, credit quality continues to perform very well with normalization of metrics consistent with our expectations. As mentioned, net charge offs were 24 basis points for the quarter. And while higher than last quarter by 8 basis points, are tracking to our guidance for full year net charge offs 25 basis points to 45 basis points.

Speaker 3

As previously guided, given ongoing normalization, non performing assets increased from the previous quarter And the criticized asset ratio increased with risk rating changes within commercial real estate being the largest component. Allowance for credit losses is higher by 3 basis points to 1.96 percent of total loans and our ACL coverage ratio is amongst the highest in our peer group. Let's turn to our outlook for the Q4 on Slide 22. We forecast loan growth of approximately 1% in the 4th quarter, which would put full year loan growth at approximately 5%, matching the lower end of our prior range. Deposits are likewise to grow in the Q4 by approximately 1%.

Speaker 3

Core net interest income for the 4th quarter is expected to decline between 4% 5% from Q3 before expanding throughout 2024 from that level. Non interest income on a core underlying basis is expected to be relatively stable. Expenses are expected to increase between 4% 5% into the 4th quarter, primarily driven by revenue related expenses associated with the expected growth in capital markets, a seasonal increase in medical claims and sustained investment in new and enhanced capabilities. We expect net charge offs for the full year to be near the midpoint of the 20 to 30 basis points guidance range. Finally, let me close on Slide 23 with a few thoughts on our management priorities for 2024.

Speaker 3

We're still finalizing our budget for next year and as always, we look to share more specific guidance during our January earnings call. 1st and foremost, we're committed to driving continued capital expansion, while we continue to optimize lending growth to drive the highest returns. As Steve mentioned, we're playing from a position strength and we expect to maintain that position as we get ahead of proposed capital regulations and phase in periods. Related to deposits, we're continuing to acquire and deepen primary bank customer relationships. This should result in continued growth of deposits into next year, while supporting our disciplined management of deposit beta.

Speaker 3

Given the expected higher for longer rate scenario, We will continue to position the balance sheet to remain modestly asset sensitive, which will support the margin and we expect will deliver growth in net interest income dollars on a full year basis. Non interest income remains a critical focus for us with sustained execution on 3 primary strategic areas for fee revenue growth: Capital Markets, Payments and Wealth Management. Over the medium term, we expect that non interest income has the potential to grow at a rate more quickly than both loans and spread revenues given the opportunities for these fee businesses. As I mentioned on expenses, We have taken considerable actions to hold baseline expense growth to a low level. This focused on sustained efficiencies, including Operation Accelerate, Business process offshoring and the other actions will yield multi year benefits.

Speaker 3

These actions are necessary to allow for the continued investment into new and enhanced capabilities, which will set up growth over the course of the next few years. We expect the net result of these actions for 2024 Will be an underlying growth rate of core expenses somewhat higher than the level we saw in 2023. Our current working estimate is underlying expense growth of approximately 4% compared to the approximately 2.5% level we were running in 2023. We believe this level of expense management is the right balance to position the company to operate within the current environment and sustain our momentum into 2025. We will also maintain our rigorous approach to credit management, consistent with our aggregate moderate to low risk appetite.

Speaker 3

Finally, to close, We believe we are exceptionally well positioned to proactively stay ahead of the evolving environment. We will be dynamic and address these numerous topics head on. And over time, we believe this will result in opportunities to benefit substantially in the coming years. With that, we will conclude our prepared remarks and move to Q and A. Tim, over to you.

Speaker 1

Thanks, Zach. Operator, we will now take questions. We ask that as a courtesy to your peers, each person ask only one question and one related follow-up.

Operator

At this time, we'll be conducting a question and answer session. Thank you. And our first question is from the line of Manan Goswami with Morgan Stanley. Please proceed with your question.

Speaker 5

Hi, good morning.

Speaker 6

Good morning, Manan.

Speaker 5

Can you talk about the puts and takes in that 4% expense growth number for next year. What sort of revenue environment does that bake in? What are the areas that are pushing up expenses? And maybe also why you have flexibility to manage more if the revenue environment is weaker?

Speaker 7

Yes. Great question. And this is Zach. I'll take that one. Just to preface it and set a framework for the answer, let me Reiterate what I said in the prepared remarks a minute ago, which is driving efficiency in our core expenses is a key priority for us.

Speaker 7

We're one of the most efficient banks in the regional And that's been a product of years of efforts. And what we're trying to do right now is strike a balance Of the short term and the medium term. In the short term, managing expenses to a low level of growth given the overall revenue environment. But also in the medium term, we see significant growth opportunities over time for Huntington, and we

Speaker 8

want to

Speaker 7

make sure that we can maintain The momentum in our key strategies and in fact, capture the higher revenue outlook that we just shared. Even as we quickly get ahead, and I stress that word quickly, get ahead of the new and expanded risk management capabilities that we'll need to operate. If you take a step back, It was just over a year ago that we were fully delivering over $500,000,000 of annual expense saves from the TCF merger. Over the last year since then, we felt underlying core expenses to 2.4%, and we did that with all the programs I've just talked about in The long term efficiency programs, proactive actions we took in the Q1 of this year and now a new set of actions that we're implementing in the Q3, including another tranche of branch optimization, accelerating the business process offshoring, Driving efficiencies across the bank and finding efficiencies in our corporate real estate portfolio. As we look at the 24, to your question, We're seeing the opportunity for incremental revenue upside, particularly in the really strong performance we've seen In our NIM management program, which is higher than our prior outlook and good momentum in the V businesses as we look forward, we want to quickly address The lessons learned from the last year's environment, address the new regulations coming around Basel CCAR, resolution planning And ultimately enhance our risk management, so we can operate in from a position

Speaker 6

of strength just as we are

Speaker 7

right now going forward, which We'll require investment. So the kind of things that are driving that roughly 1.5% higher run rate Our investment into teams like treasury, risk management, technology, it's with a focus on enhancing data, underlying process capabilities and automation. The goal in the end, I'm going to take a step back, is to get ahead of these requirements To quickly move through this period, we expect to see around a year's worth of this higher expected run rate of expenses again around 1.5% higher. And then that expense growth rate will come back down again as we exit 2024 and we'll see the underlying Core expense management come through. It all goes back to the goal of maintaining Our vibrancy, our momentum and really in terms of Huntington continues to be in the position of strength to go forward.

Speaker 4

This is Steve. Just to sort of come in over top of that, we think this is a time to be dynamic to play offense to be front footed in terms of a number of our businesses and we intend to do that and that will require investment. We'll have more college more Alex, if you will, will have some new capabilities, all of which are in the plan and the numbers Zach shared with you.

Speaker 5

Got it. And then just putting it together because you mentioned you're modeling NII trends higher as you go through 2024, there's more upside to fees. How does that play into operating leverage for next year? Do you still think you can drive positive operating leverage?

Speaker 7

It's a little odd if we give you precise guidance on that, but driving toward operating leverage over time is a key elements of our goals. You'll remember that it's one of the 3 major financial targets we set for ourselves and we do see Solid opportunity for revenue growth next year on both spread and fees. But I would stress again coming back, what's critical for us is management for the medium term At this point, and we want to make sure that we can maintain those critical investments even as we're driving the efficiencies in the underlying expense growth rate. Taught about operating leverage over time, we'll absolutely be part of the plan and we'll have to see the precise outlook for 2024 before I get into quantified that more specifically.

Speaker 5

Appreciate the detail, Anders. Thank you.

Speaker 7

Thank you.

Operator

Our next question is from the line of John Pancari with Evercore ISI.

Speaker 9

Katie, that you implied a you expect a trough in the Q4 and then expanding through 2024. Maybe can you help us frame the magnitude Of growth do you think is achievable under the current curve assumption as you look at the NII Upside and then I guess the same question would be for your commentary around the margin in terms of expansion through the year. Maybe if you can help us I'll size that up in terms of what's a fair assumption based on what you're looking at?

Speaker 7

Yes. That's a great question. This is Zach. I'll take that one. No, I think just to take a step back, we saw in the 3rd quarter really highlighted the of our overall asset sensitivity management program, we saw NIM expand and the benefits of asset repricing really Coming through into a stronger NIM, what we saw in the 3rd quarter was about 10 basis points increase in NIM From the Q2, around half of that, I will note, are items that were temporary in nature, reducing fed cash In Q3 from Q2, it drove around 3 basis points.

Speaker 7

We got some elevated levels of dividend from the FHLB Stock that was a function of Q2 FHLB borrowing, those items won't recur. However, we did see a positive 4 basis point move in underlying spread in the Q3 as I noted. As we think about Q4, Our expectation is to have to see a NIM of between 305 and 310 basis points, which is around 5 or 10 basis points better than I would have thought this time last quarter. And it's really driven by the benefits we're seeing coming through From the higher for longer rate scenario, which as we noted, we would expect to be accretive to overall NIM and that is bearing fruit. Based on the trends we're seeing in earning assets, I expect dollars of NII in Q40 down around 4% to 5% from Q3 and forming a trough, Both in NIM ratio and NIM in net interest income dollars in the 4th quarter and then trending higher from there.

Speaker 7

The NIM outlook for 2024, I expect to be flat to rising, as I noted. And I think The things you're going to see are continued really solid progress on fixed asset repricing, major asset categories on the fixed side this quarter are seeing Again, sequential increases in Q3, and we'll expect to see that continuing on, particularly in the higher for longer scenario, Even as we do see data continuing to trend as well, it will be accretive to overall spread throughout the course of next year, we think. We'll also benefit, as we noted before, during 2024 from a gradual reduction in the negative carry From the received fixed swap hedge portfolio, we estimate roughly 5 basis points throughout the course of next year on that benefit, but mainly in the second half of the year. So, Ian, I would say, I would couple that flat to rising NIM with growth in loans, growth in earning assets that, as I noted, will drive Overall NII dollars higher. We'll get more precise with guidance as we get into January, but those are the major drivers that we're seeing at this point.

Speaker 9

Very helpful, Zach. Thank you for that. And then separately on credit, criticized loans, up 17% Linked quarter, it looks like and I believe you alluded to in your comments, a lot of that was commercial real estate. Can you And I know you added to your reserve and commercial real estate non performers are also up pretty sharply. Was there A dedicated effort to scrub the portfolio that you were working through your exposures there that drove a lumpier move here or is this The deterioration that's starting to take shape as we all expect in this sector.

Speaker 10

John, it's Rich. Let me start with that, I can turn it over to Brendan to give you a little bit more color on what happened in the Q3.

Speaker 4

So if you think back

Speaker 10

to Q2, our NPA level was at 40 6 basis points, which was the lowest level we've had since the GFC. And we've had 8 consecutive quarters of declines We have been a lot of the adds to non accrual that we had in the quarter were discretionary. We have about twothree of our commercial NPLs are current Under principal and interest, the credit class is a similar story. We had reductions in 5 of the 6 Previous quarters and as you talk about credit normalizing, you would expect to see an increase in credit class So I wouldn't categorize

Speaker 4

the movements as huge jumps. I think

Speaker 10

it's just a normalization of very levels for us. But Brendan, why don't you give a little bit of insight into the Q3 specifics?

Speaker 5

Sure. Thanks, Rich. To provide us

Speaker 7

a little bit more color, Approximately

Speaker 10

for per class, approximately 60% of the increase was focused in commercial real estate and our ABL group. There are 2 places you'd expect to

Speaker 5

see higher levels. On the NPA side, it

Speaker 10

was split more equally between commercial real

Speaker 5

estate and C and I.

Speaker 10

For both NPA and credit class, as you noted, the real estate exposure was focused mostly in office.

Speaker 5

And on the C and I side, beyond

Speaker 10

the ABL concentration I mentioned, There really weren't material concentrations. So I think what you're seeing in the numbers, as Rick said, is just a bounce off a very low bottom.

Speaker 9

Okay. Thank you. Appreciate the detail.

Operator

Our next question comes from the line of Ebrahim Poonawala with Bank of America. Please proceed with your questions.

Speaker 11

Hey, good morning.

Speaker 10

Good morning, Graham.

Speaker 11

Maybe question for you, Steve. I think, I mean, you all have talked about being front footed that the banks that are talking about coming back to loan growth next year. But I'm just wondering if there's going to be a ton of loan demand to speak of for banks to lend into. Just give us a sense of what you're seeing across your footprint, where that loan demand is coming from or are you seeing Customers get increasingly cautious.

Speaker 4

Ebrahim, great question. Thank you. I believe there is a growing cautiousness, what's going on in Israel and the Middle East, what's going on in We've got a UAW strike that does not have an apparent resolution. And I think businesses are reacting to that. 99% of our customer base is privately owned companies.

Speaker 4

Rates are up. They're using their liquidity, but outlook and where rates are going, all sort of are headwinds to the next round of growth. Having said that, our businesses are doing well. We'll have good growth. We'll be within guidance that we gave you, that Zach gave you earlier in the year.

Speaker 4

We'll be up about 5 year over year. And we'll continue to see growth next year, I believe, in a couple of areas in particular. Our distribution finance is a powerful engine. It's seasonally reduced this quarter. It will be up Nick, in the Q4, and we expect to continue to grow that by winning the business.

Speaker 4

We are a significant equipment finance Lender and more and more on shoring, more automation, there will be continued demand, Albeit, probably not at the levels we saw in 'twenty two and before.

Speaker 7

That will play well. And

Speaker 4

We're a top 10 asset based lender. So all of those asset related finance activities should do well in this environment. And as you know, We are a huge small business bank. The small businesses will need more support and we'll be there for them. And Those will be sources of growth.

Speaker 4

But there's an overall more cautious outlook within our customer base just We'll have some moderate impact on, I think, on overall loan demand next year.

Speaker 11

Got it. That's helpful. And I guess a follow-up, Zach, you mentioned solid increases in fixed asset portfolio yields as they reprice. Just talk to us in terms of when these are coming up for repricing, is it just kind of playing out contractually? Is there some negotiation in terms of the spreads narrowing at the time of the pricing of these fixed rate loans?

Speaker 11

And is that kind of Impacting credit trends, are some of these borrowers looking a bit worse in terms of their ability to service the debt post repricing?

Speaker 7

Yes, great questions. Let me address those. So what I'd say is in terms of the trajectory on asset yields, we Takes it back over 200 basis points through the cycle to date, and it's really been a couple of things, most notably an intentional outcome That we've had in terms of how we're incrementally driving new loan production into and really driving for higher returns, which also is higher NIM and so we're seeing that come through in a lot of the areas where we're actively modulating and optimizing. Indirect auto, for example, is a great example of that. It yields up tremendously on the outlook over

Speaker 4

the course of the cycle.

Speaker 7

It's also though Natural outcome of the structure of the balance sheet and one of the reasons why we added the slide we did this quarter in terms of detail there was to just We're around 50% fully variable as you're seeing the benefits of higher rates come through on that portfolio, Another roughly 10% in shorter duration fixed indirect auto. As I just noted, we're seeing really sizable increases in portfolio yield there. Another 10% in ARMs with the 5 year duration, which we're gradually seeing that come through. In the higher for longer scenario, every one of those Fixed asset categories, including the longer rated remaining third of the portfolio are really staying the benefit that we've seen Just in Q3, 50 basis points increase in coupon yields across the portfolio, greater than 20 basis points increase in back book And I do think that will continue to trend here to be one of the key drivers for NIM stability and growth as we go into 2024. We're not seeing any substantive portfolio wide credit driven Yield repricing, income substance, and really it's much more fundamentally driven as I noted.

Speaker 4

And then just to add, You know, we've got a very diversified portfolio. We've been very disciplined with our aggregate moderate to low risk appetite over the years. You've seen us report quarterly Since 2010, the consumer book, which is super prime and prime on auto and resi, etcetera. So we're sitting in a position we feel the confidence in the portfolio and our ability to manage through even in a tougher cycle. And as we've said to our customer base, we've got a relationship orientation.

Speaker 4

We're here to support them, and we will we're in a position to do that with our reserves, capital, our robust liquidity and that leads us to this stance of playing offense And moving share during these next couple of years.

Speaker 11

Got it. Thank you.

Speaker 7

Thank you.

Operator

Our next questions are from the line of Scott Siefers with Piper Sandler. Please proceed with your question.

Speaker 6

Good morning, everyone. For taking the call. Hi, Scott. Hey, Zach, I guess wanted to clarify if I heard correctly, it's on the NII. Are we expecting it to grow full year 'twenty three pardon me, full year 'twenty four over 3 or just positively off the 4th quarter base?

Speaker 7

Both, Scott. Great question. I'll just clarify both. I see trajectory of growth throughout the year and on a net basis, full year growth as well, which is going to be a function of Flax rising NIMs have been pretty comparable overall full year NIM year on year as well as growth in earning assets and loans.

Speaker 6

Okay, Perfect. Thank you for that. And then wanted to kind of revisit the cost equation a bit. Maybe on the initiatives that You began in the Q3, maybe just some thoughts on how substantial they are. And I guess ultimately, I guess the Question becomes, we'll have about 4% expense growth despite these initiatives sort of begs what cost growth might have been without them.

Speaker 6

So just any sort of further thoughts on exactly where we're investing, what these will ultimately end up driving,

Speaker 7

Yes. Terrific question. Let's appreciate Jen to expand on that. If I think about the equation We're managing in 2023. We've been seeing up around 2%, 2.5% underlying Expense growth and that's with the benefit of significant efficiencies that were generated this year.

Speaker 7

I estimate that around 1% benefit expenses in 2023 from these cumulative initiatives running for the last 6, 18 months and self funding Underlying investments, we've talked about this model before, driving efficiencies in the core, keeping the underlying core at a low level With the funnel, an outsized level of investment and expense growth into key investment areas like tech, marketing, new additions of personnel strategies. Those underlying investments are up almost 20% in 2023, which is what fuel follow the As we go into that model is what drove the overall roughly 2.5% growth I think what we're seeing as we go into 2024 is roughly similar sort of underlying Expense management program, really modulating down somewhat the underlying adjustments in light of the environment clearly, But also bearing some modest incremental impacts of just the cumulative inflationary environment and the efficiencies will rise As well. And so the net kind of underlying run rate that I would have expected into next year was around 2.5%. And then on top of that, we are Accelerating again these investments in regulatory response risk management capabilities that represent the additional 1.5 Percent expense growth as we go into next year, that's the 4% trajectory.

Speaker 7

If I think about where we're investing, I'll just touch on this briefly. We'll continue to focus on core strategy investments, delivering the TCF revenue synergies, growing our commercial bank through vertical Specialties expertise, digital and product development in our consumer banking and business banking division Continue to drive the fee revenue strategies in capital markets, payments and wealth. And then on top of that, clearly dealing with these Additional areas around Basel III, CCAR, liquidity and interest rate risk management, resolution planning And data and automation.

Speaker 4

You'll also see Scott, it's Steve. Just to add on, You'll also see several new initiatives that are also included in that number of 4%

Speaker 7

We'll be announcing Q4 and Q1.

Speaker 6

Okay, perfect. And I guess just one final piggyback question. The 4th quarter cost increase, will that include any unusual charges the way we saw this quarter?

Speaker 7

So we saw around $15,000,000 of one time costs this quarter. Some portion of the One time costs that we expect to arise as a result of the new initiatives were taking place were not able to be accounted for within the 3rd quarter. I'm expecting roughly $10,000,000,000 additional one time expenses in the 4th quarter related to those same initiatives. That's not Included in the guidance that I gave earlier relatively de minimis in the grand scheme of things. So the total one timers related to those actions I expect to be approximately 20 $5,000,000 in total, of which again we've taken $15,000,000 in the

Speaker 8

P and L on Q3.

Speaker 6

Okay. All right. Perfect. Thank you all very much.

Operator

Our next question is from the line of Matt O'Connor with Deutsche Bank. Please proceed with your question.

Speaker 6

Good morning. So just circling back on capital, obviously strong really any ratio you look at and including AOCI. I understand the logic of Building capital from here given uncertain macro and you're trying to lean in the business. But is there a level that you're like once we get here, It's just more than we need under almost any scenario and you'd love to deploy it more aggressively?

Speaker 7

Yes, it's a great question. Let me take a minute to expand on that. As you know, driving capital higher from here is a key focus. We have fully transitioned within the company to managing the primary metric of CET1 inclusive of AOCI. And on that basis, we're at 8% in the 3rd quarter.

Speaker 7

Our operating range for is between 9% and 10%. And so we want to drive that 8% ratio up into that operating range Between 9% 10%, and that's the key goal. I think by the time we get there, I expect that we will have significant confidence in being able to do that, by the way, over time. By the time we get there, presumably, we'll have Clarity around the final Battle of 3 requirements, any other implications to capital coming out of the new regulatory environment and we'll be able to also reassess where the macro environment is and where the lending trajectories are a little bit to The question was asked earlier. And so hard to tell exactly where within that range we'll want to go.

Speaker 7

But my expectation is once we get into that range, There will be an opportunity to get back to a more normalized capital distribution model, support elevated and Longer term run rate levels of loan growth that we've seen in the past and move through it. I'll just tack Our current working hypothesis and modeling estimate around the Basel III proposal, if it was adopted exactly as was proposed, is roughly five percent increase in RWA based on the phase in schedule that was proposed as part of the NPR, That wouldn't be phased in until 2027 and would represent about 40 bps of CET1 in 2027, again, As that proposal is written. And so part of this is just quickly get ahead of that even as far out of time as that really And allow us to really move forward in our front foot starting in 'twenty five and beyond from an accelerated loan growth

Speaker 6

Got it. That was helpful. And then just quickly squeeze in the mark to market impact of the pay fixed swaptions. Maybe it's a silly question, but do we just kind of put in some gains when rates go up and then if rates go the other way, is it mark to market On the negative side or how should we think about modeling that and the drivers?

Speaker 7

Yes, let me expand on I'll put strategic context on it and then I'll answer it. It's just the bottom of the question. The strategy of those instruments to protect capital against really substantive upgrade scenarios. When we purchased them, they were roughly 200 basis points out of the money. You've got about a 9 to 12 months sort of forward life and they would be designed to protect A third to maybe as much as 45 percent of the securities value of risk in those really substantive about 200 to 300 basis point shock scenarios.

Speaker 7

I think we put a lot of them on early in the second quarter. We added to that portfolio earlier in the 3rd quarter. We've spent roughly $30,000,000 in premium, so in our view, a pretty small insurance policy for a very significant benefit in those shock scenarios. What we've seen thus far Gains, we saw $18,000,000 of gain in Q2, dollars 33,000,000 of gain in Q3, that's a $51,000,000 cumulative gain. I'll tell you if you were to strike them, right now you'd see another gain into the Q4, but clearly they get to March at the very end of the quarter.

Speaker 7

The answer is yes in the near term. If rates rise, you would see a gain in them. If rates fall, you would see a loss in them. The key thought process for us is how critical is that insurance policy to continue to maintain. And so versus the gain in them, if we continue to hold them, I would expect that over time they would expire unused and out of the money.

Speaker 7

And you would see that gain run back through as a negative 3rd fee income if they weren't closed out. And We will be dynamic and continuing to watch the interest rate outlook with a primary focus on protection of capital. At this point, again, Pretty de minimis cash outlay for a really strong insurance policy.

Speaker 6

Okay. That makes sense. Thanks for the details.

Operator

Our next questions are from the line of Ken Usdin with Jefferies. Please proceed with your questions.

Speaker 12

Hey, good morning. Steve, I know you talked about generally a little bit of softening demand out there. But I wanted to ask you On your auto business, I did notice that your originations were up and obviously a lot of peers have pulled away from this business and it's a business that you guys have been historically very Strong and now has really good incremental yield. Just wondering if that's at all an opportunity set and have you kind of how do you think through reengaging there as one of those potential growth engines, especially as you've been able to show deposit stability? Thanks.

Speaker 4

Ken, great question. And auto has performed very, very well for us. We have confidence in its credit and spreads are very attractive now. It's a cyclical Hi, Oscar. And in the past, when spreads have widened, we've chosen to do a bit more.

Speaker 4

We'll be dynamic We look at this as the interest rate environment clarifies and it's a short it's a relatively short asset. It's roughly a 2 year average duration. So we like this asset class a lot, and we certainly like it countercyclically. And that will be something we'll be looking at Closely as we went in 2024 and 2025.

Speaker 12

Okay, great. And then last thing, Zach, just looking at what you Moved around a little bit on swaps portfolios. Can you just kind of walk us through some of your decision trees with regards to This quarter's terminations and locking in here and any anticipated future activity you're thinking about in terms of just the book as it And going forward, thank you.

Speaker 7

Absolutely, absolutely. And I will tell you this is a very dynamic and active discussion. It's a weekly pretty rigorous and data analysis process that we do and it's always focused on 2 key strategies, protecting capital Against upgrade scenarios and protecting NIM against downgrade scenarios. I'd like to note in the prior question around the pay fixed swaptions, we did During the quarter to that, anticipating that rates had a strong potential of moving higher and want to protect capital against that. And we did and raised in fact, we saw clearly and so that benefited us there.

Speaker 7

But what's interesting as well is that the curve has in a more efficient manner with less upfront negative carry is increasing. I would say as it relates to that, our view is still Legging into it, no big bets, and we're seeing very significant benefits just come through in the base asset sensitivity clearly. But over the longer term, think out into 25%, 26%, 27%,

Speaker 4

we

Speaker 7

certainly want to protect those revenue streams And we'll be seeing opportunities to increase downgrade hedging here if the environment continues to be what it is. In the meantime, it's more of an optimization, You saw us exit some received fixed swaps in Q3. Those were mainly shorter duration, just less efficient structures. By exiting them, we increased the capacity to re up for log restructures. We entered into some collars, Which will give us the option for down rate hedging if rates are attractive out into the future.

Speaker 7

And And

Speaker 4

I do suspect that there

Speaker 7

will be more of that down rate hedging opportunity as I noted just a second ago, as we go through our Q4 into the early part of next year,

Speaker 4

If the curve continues

Speaker 7

to be the way it's shaped now.

Speaker 12

Okay. And is there a way of kind of just putting all that Together in terms of like the net impact of the swaps book on your NII and Is that getting better going forward or worse? Can you just kind of help us put it in context, if you can?

Speaker 7

Yes, absolutely. That's a great question. So just zooming into 24 for a second based on the swaps that we've got in the portfolio today, I do expect We're seeing roughly a 15 to 17 basis point drag in current mail. It was 15 in Q3, expect to be roughly 17 bps of drag in Q4 of 2023 from the overall Swaps coming through now. As I noted in one of the earlier questions in this hour, by 2024, I expect that to reduce by about 5 bps, Particularly, I think the second half of the year when the curve starts to fall in the forecast.

Speaker 7

Yes. So that's probably the best way to answer your question. In the end, the goal is to call it and then really just to support it in this second range from here as we can.

Operator

Thank you. Our next question is from the line of Erika Najarian with UBS. Please proceed with your question.

Speaker 11

Hi, good morning. My questions have been asked and answered. Thank you.

Speaker 7

Thanks, Eric. Thanks, Eric.

Operator

Our next question is from the line of Jon Arsham with RBC Capital Markets. Please proceed with your question. Hey,

Speaker 13

Rich or Brendan, what's the message you want to send us on The outlook for provision and reserves, I mean it feels like you feel fine on credit, but I'm curious if you feel you need to build reserves and how you want

Speaker 10

Yes. Let me just start with kind of where we are in the quarter. We bumped up by 3 basis points. Our coverage Just given the uncertainty that we've got there.

Speaker 4

Where we go from here,

Speaker 10

I mean, we don't give specific guidance around The coverage ratio is virtually around the provision, but it's going to depend on where the economy goes.

Speaker 4

And to the extent that We

Speaker 10

see further weakening. We'll reevaluate it. But I would imagine that any builds from here would be similar to what you would see In the Q3, fairly nominal from a dollar standpoint. We might be moving some things around. But in general, we feel really good about where the reserve is right As

Speaker 4

we get to the other side of this and

Speaker 10

the economic outlook starts to improve, I could see us bringing the coverage ratio back down into that 160 range over time. So, we'll look at it every quarter, gentlemen, but we feel good about the $196,000,000 right now.

Speaker 7

Yes, okay.

Speaker 13

Late in the call, Steve, but just a bigger picture question for you. You had a good quarter, but When I saw the guide for the Q4 for lower NII and higher expenses and then heard the expense guide 'twenty four, you kind of pulled back some of that optimism. I guess my bigger and I think you understand that, but my bigger Picture question is, what's the message for 2024? Is that is it a year of investment and you're not going to push revenue growth Or are we just all being a little bit too pessimistic here and just focusing on the expenses and some of the near term NII headwinds?

Speaker 4

Jack also talked about improving net interest income and NIM at 24%. So, I don't think of that as our outlook is motto of a negative nature. We're investing in the businesses. We're going to do a number of things that I think will position us really well for the medium term like 2025, 26 In terms of further growth, we'll have some new capabilities and some additional talent in the company. We'll be in a position To manage with data and processes even better as we go forward, we're accelerating some of our multiyear plans End of 'twenty four.

Speaker 4

And as Zach said, that growth in outlook for expenses in 'twenty five comes back to A more normal level. So this is us being intentional, positioning the company to play offense, and We think we're in that position. We're confident on our credit. We've got good and growing capital on both the gross and an adjusted basis. Liquidity is exceptional.

Speaker 4

The deposit growth continues. And as you saw in 20 And

Speaker 7

for those who were around in that period of

Speaker 4

time, there are moments to take advantage. That's when we launched AirPlay, that's when we did a number of things in the commercial bank And really opened up SBA lending, etcetera. We think this coming year is one of those moments and we intend to play offense.

Speaker 13

Okay. So it's okay, that's good. I had to ask it, Steve, I'm getting asked that question, but I just needed to know if you're optimistic or pessimistic For 2024 and it sounds like you're

Speaker 4

We are optimistic about 2024 and beyond. And beyond, John. All right.

Speaker 7

All right. Okay. Thank you. Thank you.

Operator

Our final question is from the line of Steven Alexopoulos with JPMorgan. Please proceed with your questions.

Speaker 8

Hey, good morning, everyone.

Speaker 7

Good morning, Steve.

Speaker 8

Steve, I've heard all the Commentary for the past hour on expenses. And I guess what I still don't understand is, is the step up in expense growth in 2024, is that tied to you A better revenue environment to absorb a higher level of spend. There is something going on that's going to require you to spend more in 2024 Agnostic to the revenue environment. So,

Speaker 4

we are gearing the company to We manage the growth dynamic that we expect will be in place in 2024 and beyond. We also are accelerating Certain multiyear investments into 2024. So we're in an even better position with data, and it's principally data To manage in managing the company, right? We're at a different scale now post GCF, we saw a lot of unique activity in March around Silicon Valley. Things moved very quickly.

Speaker 4

We want I want and the Board wants better data, better access to information That we have and pushing a button together. So we've been on a multiyear journey. We're going to pull that forward And position the company to be even stronger. And we've been managing market risk, as you've We're hedging about half of our AFS portfolio since 'nineteen, but our processes Have not been as automated as we would like them to be given the speed at which things can change. And so We said we would take advantage of lessons learned out of Silicon Valley and others in this most recent episode, and that has Resulted in us making a number of adjustments in our treasury and alcohol policies that I think will improve To further bolster our aggregate moderate to low risk appetite and then these investments in data and some other areas in addition to the revenue

Speaker 8

And Will, that's the pace of investment. Is that a 2024 story? Or is this a 2024 and beyond story?

Speaker 4

We're trying to pull things forward into 'twenty four, as Zach said. And then as we think about 25 and beyond will be back to a more normalized. Again, this was an election on our part, part of an overall view of trying to take advantage Of the environment that we see in 2024 and beyond and position the bank for growth? I liken it to what we did in 'ten and 'eleven.

Speaker 8

Yes. Well, it sounds like it's partially opportunistic and partially you need to invest in systems, right? It sounds like that's a portion of

Speaker 4

We have multiyear plants that were accelerating. That's choice.

Speaker 5

Okay.

Speaker 4

If I

Speaker 8

could ask you one last question. So

Speaker 6

I don't know if you

Speaker 8

caught Brian at first Horizon recently was asked about crossing $100,000,000,000 said, well, you really don't want to Plus, organically, right? You don't want to be 101. But you guys at $186,000,000,000 today, how do you see this with these proposed Change is coming. You think you're in a good spot at this asset level? Or do you think you need to boost size and scale too, just given what is potentially coming?

Speaker 8

Thanks.

Speaker 4

We own the risk at risk management. We're going to maintain this aggregate moderate to low risk appetite. We've done things well in the past. We'll continue to do them in the future. I think the size of the business is It's not the only determinant.

Speaker 4

I think the business model itself is very, very important. Part of the strategy over time is to be deep in certain markets For our consumer and regional bank giving us brand awareness and other attributes that let us continue to grow the core. And then we've invested selectively in a variety of commercial businesses. Our asset finance, equipment finance, ABL, The distribution finance, a number of these businesses that and beyond, especially businesses that are national in nature, Complemented by things that we've added on the payment space last year, the acquisition On the investment banking side, all of which give us more product and capabilities to bring to our customer base. And we're going to continue that.

Speaker 4

We've alluded to additional talent and capabilities in the near term, and We expect to be in a position to start talking about that. But all of that's in that 4% guidance for you for next year.

Speaker 7

Okay. Thanks for taking my questions. Thank you. Great question.

Speaker 4

Okay. So we're grateful for you joining us today. I just want to compliment Rich Foley one more time. We did this last year. He's got a retirement coming At the end of the year, Rich has just been a terrific leader.

Speaker 4

We've greatly benefited from your experiences. Rich, you Position us well as you've heard on the call. So thank you very much. In closing, we're pleased with the 3rd quarter results as we dynamically manage through this environment. We believe we're very well positioned for times such as these with strong credit quality, improving capital ratios and robust liquidity, And it's supported by consistent efforts from our 20,000 colleagues across the bank to deliver these results.

Speaker 4

We are a team, you know this, of disciplined operators and we're executing on our strategy that we outlined last year at Investor Day, and we're driving shareholder value. We're optimistic we're going to continue to do that in the years to come. And as a reminder, we're all aligned. The Board executives and our colleagues are top 10 shareholder collectively, and we feel the pain of this market pullback. We're very focused on driving consistent strong performance.

Speaker 4

So thank you for your support and interest in Huntington and have a great day.

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Earnings Conference Call
Huntington Bancshares Q3 2023
00:00 / 00:00