Huntington Bancshares Incorporated (NASDAQ:HBAN) Q4 2022 Earnings Call Transcript

Huntington Bancshares Incorporated (NASDAQ:HBAN) Q4 2022 Earnings Call Transcript January 20, 2023

Operator: Greetings. Welcome to Huntington Bancshares Fourth Quarter Earnings Call. As a reminder, this conference is being recorded. At this time, I’d now like to turn the conference over to your host, Tim Sedabres, Director of Investor Relations.

Tim Sedabres: 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 at www.huntington.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; Zach Wasserman, Chief Financial Officer; Rich Pohle, Chief Credit Officer, will join us for the Q&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.

Steve Steinour: Thanks, Tim. Good morning, everyone, and welcome. Thank you for joining the call today. We are very pleased to announce our fourth quarter results, which included GAAP net income of $645 million and adjusted net income of $657 million. For the full year, reported GAAP net income was $2.2 billion, and adjusted net income was $2.3 billion. Both results reflect record earnings for Huntington. 2022 marked a year of numerous successes driven by our team’s execution of organic growth initiatives, realization of both expense and revenue synergies from the TCF acquisition. An unwavering focus on credit discipline and proactive balance sheet management. We ended the year with substantial momentum. Clearly, the economic environment is becoming increasingly challenging.

However, Huntington is better positioned today than at any time since I joined over a dozen years ago. And over those years, we’ve transformed the risk profile of the bank and remained highly disciplined. We are taking proactive steps now to again position Huntington to outperform, and we entered the year with solid capital levels, top-tier reserves, a growing core deposit base and strong credit metrics. We continue to see opportunities to grow revenue and profit. Now on to Slide 4. First, we finished the year with our fourth consecutive quarter of record pre-provision net revenue. This was supported by higher interest income driven by earning asset growth and an expanded net interest margin. Revenue growth has been exceptional over the course of the year, and we intend to protect and grow that revenue base.

Second, we delivered broad-based loan growth ex PPP up 10% year-over-year. As we drove this growth, we also optimized for return while still exceeding our loan growth outlook. One example of this optimization is indirect auto, where our production in the quarter was approximately 15% lower than the prior quarter, while our new loan yields increased by over 100 basis points. Importantly, we continue to grow our deposit base with multiple consecutive quarters of growth. We believe this is a differentiator for Huntington in this environment. It also demonstrates the breadth of our franchise and our colleagues’ ability to acquire and deepen primary bank customer relationships. Third, our financial results for the fourth quarter and full year reflect a top-tier return profile and were at or above our medium-term targets.

These results demonstrate the earnings power of the company, and we expect to continue to deliver on these targets. As we intended, we delivered common equity Tier 1 capital to the middle of our 9% to 10% operating range. We are also very pleased to announce a new 2-year share repurchase program. Fourth, we ended ’22 with strong momentum across the business that we carry into this new year. We remain focused on growth, aligned with our risk appetite. Importantly, we have the capital, credit reserves and strength of balance sheet that give us confidence to continue to deliver on our organic growth priorities. Slide 5 highlights the tremendous earnings power of the franchise, which has improved sequentially over the course of the year. PPNR is over 60% higher than pre-pandemic levels.

Our return on tangible common equity is top tier. We managed our asset sensitivity throughout the year and deliberately positioned the company to benefit from higher interest rates, which resulted in significant revenue growth. We’ve also been prudent in taking actions to protect this revenue base should we experience lower rates over the next few years. We will continue to be dynamic in this regard with our goal of reducing volatility and creating a tight quarter around the path of spread revenue. At our Investor Day in November, we shared with you our highly defined set of strategic priorities. We expect these strategies will drive sustained revenue growth and support gains in efficiency over the long term. As you also heard, this management team is a group of experienced operators.

To further accelerate the execution of these strategies and support increased efficiency, we will be taking a series of actions during ’23 to align our organizational structure with a focus on our critical priorities. We expect these actions will result in new growth and efficiency opportunities. We will share more details on these actions as they’re finalized over the course of the first quarter However, one element will be a voluntary retirement program for our middle and senior management. Overall, I believe this program will be important to support our colleagues and create value for our shareholders. In closing, we are well positioned for continued growth. We have the strategies and the momentum in our businesses to support growth. We also benefit from highly engaged colleagues who have consistently delivered outstanding customer service and are a true differentiator.

We have a credit discipline to outperform and remain focused on rigorous expense management, investment prioritization and capital allocation. We remain committed to our long track record of managing to positive annual operating leverage and are intently focused on driving shareholder value. Zach, over to you to provide more detail on our financial performance.

Zach Wasserman: Thanks, Steve. And good morning, everyone. Slide 6 provides highlights of our fourth quarter results. We reported GAAP earnings per common share of $0.42 and adjusted EPS was $0.43. Return on tangible common equity, or ROTCE, came in at 26% for the quarter. Adjusted for notable items, ROTCE was 26.5%. Further adjusting for AOCI ROTCE was 19.8%. Loan balances continued to expand as total loans increased by $1.9 billion and excluding PPP, increased by $2.1 billion. Deposit balances increased by $1.6 billion on an end-of-period basis, while average deposits were essentially flat compared to the prior quarter. Pre-provision net revenue expanded sequentially by 4.2% from last quarter to $893 million. And on a full year basis, year-over-year increased by 36% to $3.2 billion.

Credit quality remained strong with net charge-offs of 17 basis points and nonperforming assets declining to 50 basis points. Turning to Slide 7. Average loan balances increased 1.7% quarter-over-quarter driven by both commercial and consumer loans. Commercial loans continue to represent the majority of loan growth within commercial, excluding PPP, average loans increased by $1.9 billion or 2.7% from the prior quarter. Primary components of this commercial growth included distribution finance, which increased $900 million tied to continued normalization of dealer inventory levels as well as seasonality with shipments of winter equipment arriving to dealers. We also saw the continued long-term trend of demand within our asset finance businesses, which drove balances $300 million higher in the quarter.

Commercial real estate balances increased by $500 million largely as a result of production late in the third quarter and lower prepays. End-of-period balances were higher by $180 million. Auto floor plan utilization continued to normalize which drove balances higher by $300 million. Additional increases in line utilization over time, represents a substantial ongoing opportunity. We also saw higher balances in specialty verticals. Such as mid-corporate and tech and telecom, which were offset by lower balances in other areas as a result of our return optimization initiatives. In Consumer, growth was led by residential mortgage which increased by $500 million as on sheet production outpaced runoff and was supported by slower prepaid speeds. Partially offsetting this growth were lower auto balances, which declined by $230 million and RV Marine, which declined by $50 million.

Turning to Slide 8. We delivered $1.6 billion of deposit growth for the quarter and $4.6 billion for the year on an ending basis, on an average basis, deposits were lower by while increasing 2.4% year-over-year. Competition for deposits has intensified, beginning in earnest in September and continuing into the fourth quarter. Notwithstanding that, we are pleased with the traction we saw over the course of the quarter as our teams delivered robust production, demonstrating the deposit gathering capabilities across the bank. Ending deposit growth was led by consumer, which increased by $1.6 billion. We saw a mix shift in line with our expectations, including incremental growth in both money market and time deposits. We continue to remain disciplined on deposit pricing with our total cost of deposits coming in at 64 basis points for the fourth quarter.

We will remain dynamic balancing core deposit growth, the competitive rate environment and the utilization of a broad range of funding options. On Slide 9, we reported another quarter of sequential expansion of both net interest income and NIM. Core net interest income, excluding PPP and purchase accounting accretion, increased by $67 million or 5% and to $1.459 billion. Net interest margin expanded 10 basis points on a GAAP basis from the prior quarter and expanded 11 basis points on a core basis, excluding accretion. Slide 10 highlights our high-quality deposit base and diversified funding profile. For the current cycle to date, our beta on total cost of deposits was 17%, as we have noted, we expect deposit rates to continue to trend higher from here over the course of the rate cycle.

Overall, our beta continues to track to our expectations. Turning to Slide 11. Throughout 2022, we were deliberate in managing the balance sheet to benefit from asset sensitivity. We also incrementally added to our hedging program to manage possible downside rate risks over the longer term. During the quarter, we executed a net $3.2 billion of received fixed swaps and $800 million of forward-starting swaption collars. At this point, based on the current rate outlook and yield curve opportunities, we believe we have optimized the size of the program. We are comfortable with our position today as we balance near-term costs versus longer-term protection. As always, we will be dynamic as we monitor the outlook and the yield curve. We maintain unused hedge capacity that we could deploy should the curve revert and/or steepen to a level where we would add incremental downside rate protection hedges.

On the securities portfolio, we saw another step-up in reported yields quarter-over-quarter. We are benefiting from reinvestment as well as the hedge strategy to protect capital. We will continue to reinvest cash flows of approximately $1 billion each quarter, at attractive new purchase yields around 5%. Moving to Slide 12. Noninterest income was $499 million, up $1 million from last quarter. We drove record activity within our capital markets businesses during the quarter and throughout 2022. Capstone continued to perform well and our underlying capital markets businesses outside of Capstone finished the year strong, up 26% year-over-year. We remain pleased with the client engagement we are seeing in the wealth management business with another positive quarter of net asset flows.

On a year-over-year basis, we saw lower mortgage banking income as a result of the higher rate environment and from lower deposit service charges from fair play enhancements we implemented during 2022. Offsetting these factors were higher capital markets revenues and payments revenues. Importantly, we’re executing on our strategy to drive higher value revenue streams and our fee mix continues to trend favorably. Moving on to Slide 13. GAAP noninterest expense increased $24 million compared to the prior quarter. Adjusted for notable items, core expenses increased by $19 million. This quarterly increase in core expenses was primarily the result of revenue-driven compensation tied to capital markets production. Additionally, we saw seasonally higher medical claims in the quarter, which increased by $16 million.

Underlying these results, core expenses were well controlled, demonstrating our commitment to disciplined expense management. Slide 14 recaps our capital position. Common equity Tier 1 increased to 9.44%. Our tangible common equity ratio, or TCE, increased to 5.55%. Adjusting for AOCI, our TCE ratio was 7.3%. We ended the year having delivered on our plan to drive common equity Tier 1 to the middle of our 9% to 10% operating range. Going forward, our capital priorities have not changed, fund organic growth, support our dividend and provide capacity for all other uses, including share repurchases. After having held back on share repurchases for the last several quarters, our expectation is that over the course of 2023 and beyond, we will now return to a more normalized capital distribution mix, including share repurchases.

Our Board has authorized a $1 billion share repurchase program through the end of 2024. Given the current economic outlook, our thinking is that we will not actively repurchase shares during the first half of 2023. And as we watch the path of the economy. This may result in capital ratios continuing to expand in the near term. We like the flexibility the program provides, and we believe it is prudent to maintain an authorized share repurchase program as part of our overall capital management framework. On Slide 15, credit quality continues to perform very well. As mentioned, net charge-offs were 17 basis points for the quarter. This was higher than last quarter by 2 basis points and up 5 basis points from the prior year as credit performance continues to normalize.

Nonperforming assets declined from the previous quarter and have reduced for 6 consecutive quarters. Criticized loans have similarly improved for 4 consecutive quarters. Allowance for credit losses was up slightly, driving the coverage ratio higher to 1.9% of total loans. Turning to Slide 16. You will note a strong reserve position. As I mentioned, the portfolio has continued to perform extraordinarily well, and we believe our disciplined approach to credit through the cycle underpins the overall strength of our balance sheet. We were pleased to update our medium-term financial targets at Investor Day in November, and these form the foundation of our expectations over our strategic planning horizon. We believe these metrics are at the core of value creation.

Profit growth, return on capital and the commitment to drive positive annual operating leverage. Turning to Slide 18. Let me share some thoughts on our 2023 outlook. As we discussed at Investor Day, we analyze multiple potential economic scenarios to project financial performance and develop management action plans. Our targets are anchored on a baseline scenario that is informed by the consensus economic outlook and the forward yield curve as of December 31. The baseline assumes a mild recession in 2023 with modest net GDP growth for the full year. The economy is expected to exit the year on the path toward recovery with inflation gradually subsiding. Since Investor Day, the economic outlook is incrementally worse and is likely at the lower end of the baseline scenario outcomes.

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Our baseline outlook for 2023 is for average loans to grow between 5% and 7%, led by commercial with more modest growth in consumer. We will continue to focus on optimizing for returns and driving loan expansion in select areas. Deposits are expected to increase between 1% and 4%, reflecting continued growth and deepening of customer and primary bank relationships. Net interest income is expected to increase between 8% and 11%, driven by continued earning asset growth and expanded full year net interest margin. Noninterest income is projected to be approximately flat. We expect continued robust performance from our areas of strategic focus: capital markets, payments and wealth management. During 2023, several other factors are offsetting that growth including our anticipated holding of the majority of our SBA loan production on sheet, thereby reducing near-term fee revenue in favor of longer-term high-return spread revenue.

Lower income of approximately $23 million associated with purchase accounting accretion in fees. Please refer to Slide 30 for more details. Lower operating lease revenue as we continue to transition to more capital leases. Importantly, we expect this will result in lower operating lease depreciation expense as well. Lower mortgage banking income for the full year 2023 versus 2022. And finally, in light of the economic outlook, we are implementing risk mitigating deposit policy changes that will result in a lower incidence of overdrafts and related service charges. In addition, we are reducing NSF fees to 0 in the first quarter. This will result in an approximate $5 million reduction in fee income per quarter, which we expect to be more than offset by lower associated charge-offs.

As you know, the first quarter is generally a seasonal low for overall fee income. We expect fee income will grow sequentially throughout the remainder of the year. On expenses, as Steve noted, we intend to hold growth to a low level given the environment, even as we remain committed to funding critical long-term investments. We plan to manage core underlying expense growth between 2% and 4% for the full year. This level of expense growth benefits from the ongoing efficiency initiatives we’ve discussed previously, such as Operation accelerate, branch optimization and the organizational alignment actions that Steve highlighted. Added to the core expense growth, we expect approximately $60 million higher expenses from the full year run rate of Capstone in Toronto, and $33 million of increased FDIC insurance expense associated with the surcharge.

In addition, we expect the first half of the year to include some amount of restructuring charges associated with the expense management actions we are taking. We will provide more details about these actions later in the quarter. Overall, our low expense growth coupled with expanded revenues, is expected to support another year of positive operating leverage. We expect net charge-offs will be on the low end of our long-term through-the-cycle range of 25 to 45 basis points. Our 2023 guidance reflects the current macroeconomic outlook. We will continue to be diligent in analyzing the macro environment and will react as needed to manage as the year plays out. We ended 2022 in a position of strength and have good momentum. We have every expectation of continuing to outperform this year.

With that, we will conclude our prepared remarks and move to questions and answers. Tim, over to you.

A – Tim Sedabres: Thank you, 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. And then if that person has additional questions, he or she can add themselves back into the queue.

Q&A Session

Operator: Our first question is from the line of Manan Gosalia with Morgan Stanley.

Manan Gosalia: Question on deposit growth. You mentioned deposit competition has intensified quite a bit. And we can see from the CD rates that you’re offering in the market that you’ve been proactively raising the CD rates and offering more 14-month CDs. So just given all of that, can you talk about how much of the projected deposit growth in 2023 will be driven by CDs? And what the overall deposit mix is likely to look like?

Zach Wasserman: Sure. Yes. This is Zach. I’ll take that question. Thank you for asking it. Generally speaking, we’re seeing our deposit growth continue to trend pretty well in line with the outlook that we’ve given between 1% and 4% growth for the full year. So we think we’re on that run rate. I think it will be balanced between both consumer and partial and to your point, we’ll continue to the mix of that deposit gathering will continue to trend as we expected and it is baked into our overall rate and beta expectations for higher rate products like time deposits like money market et cetera. I think we’re beginning — we’re operating in this rate cycle clearly at a lower level of mix of those products than we were, for example, the last rate cycle.

So we’ll see that trend higher throughout the course of the next several quarters, but in line with our general expectations, it all comes back to our focus on deepening relationships with our existing customers and our primary bank relationships. And so we think it’s it’s working pretty well and expected to continue as we go to..

Manan Gosalia: Got it. And then maybe on the NIM trajectory from here, can you comment on if we’re close to peak. And given what you said on the hedges and the fact that the program, at least for now. I mean how should we think about a floor for NIM from here over the course of the next 4 to 8 quarters, as I said, does start cutting rates.

Zach Wasserman: Yes. On the topic of NIM, I think just take a step back, we’ve significantly benefited over the last 2 quarters from explicit actions to manage asset sensitivity seen more than 60 basis points NIM expansion in the last 3 quarters alone. And that was very intentional with in mind towards continuing our top-tier performance in NIM over the course of long periods of time that we’ve done. As we stand now, as we start to look into we do believe there’s more room to go on asset bases, and we’ll see yields continuing to increase out over the next few quarters. However, we’re further along in that process probably 3 quarters of the way through than we are on the deposit beta side, but we also expect, as we said, rates continue to track higher over the course of the next several quarters, we’re probably only about halfway through the deposit beta cycle.

And when you couple that dynamic with what is currently expectation, the yield curve that we’ll see short-end rates fall towards the latter part of 2024. It is reasonable to project a somewhat downward trajectory of NIM over the course of 2023. Our goal will be to manage NIM, as we’ve said on a number of occasions previously within a tighter corridor in 2023 as we can, really protecting the downside hedging program and ultimately driving towards sequential and sustained growth in net interest income on a dollar basis. And I think when we couple what we expect to be a pretty strong NIM level overall with the loan growth that we expect to continue to drive, again, to the guidance 5% to 7% over the course of this year, we’ll see that NII on dollar rate is continuing to expand, and it’s about focus.

Operator: Our next question is from the line of Steven Alexopoulos with JP Morgan.