Huntington Bancshares Incorporated (NASDAQ:HBAN) Q3 2023 Earnings Call Transcript

Huntington Bancshares Incorporated (NASDAQ:HBAN) Q3 2023 Earnings Call Transcript October 20, 2023

Huntington Bancshares Incorporated beats earnings expectations. Reported EPS is $0.36, expectations were $0.32.

Operator: Greetings. Welcome to the Huntington Bancshares Third Quarter Earnings Call. At this time all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. At this time, I would 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, 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; and Zach Wasserman, Chief Financial Officer. Rich Pohle, Chief Credit Officer, and Brendan Lawlor, Deputy 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.

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

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. Second, we’ve managed top quartile CET1 inclusive of AOCI. We will continue to drive additional capital expansion for the remainder of this year and over the course of 2024. Third, 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.

Fourth, 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. 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 in our commitment to drive operating efficiency over time with continued execution of proactive expense management programs. We expect a 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. 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. 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 and 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 sixth 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.

However, thus far in the cycle, overall, our customers are effectively managing through it. We remain highly vigilant in our 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. 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 third quarter results. We reported GAAP earnings per common share of $0.35 and adjusted EPS of $0.36. The quarter included $15 million 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%. Further adjusting for AOCI, underlying ROTCE was 15.3%. Average deposits grew during the quarter, increasing by $2.6 billion or 1.8%. Loan balances decreased by $561 million or one-half of 1% 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 third quarter, including branch consolidation, staffing efficiencies, and corporate real estate consolidations. 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 one-half of 1% from Q2, driven primarily by lower commercial loan balances, which decreased by $1.2 billion, or 1.7% from the prior quarter.

On a year-over-year basis, average loans increased 3.3%, reflective of our intentional optimization efforts. Primary components of the commercial loan change included CRE balances, which declined by $387 million, driven by paydowns. Distribution finance decreased $434 million due to normal seasonality with lower dealer inventory levels in the third quarter before the expected inventory build in the fourth quarter. Asset finance decreased by $271 million. Auto floorplan increased by $122 million, all other commercial categories net decreased as we continued 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. Average deposits increased by $2.6 billion or 1.8% from the prior quarter. Turning to Slide 9, we saw sustained growth in deposit balances in the third quarter, including sequential increases during July, August, and 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 second quarter, and we continue to expect this mix shift to moderate and stabilize during 2024.

On to Slide 11. For the quarter, net interest income increased by $22 million, or 1.6% to $1.379 billion, driven by expanded net interest margin. We continued to benefit from our asset sensitivity and the expansion of margins that has occurred throughout this cycle, with net interest income growing at 9% CAGR over the past two 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. 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. The higher for longer scenario today assumes one additional rate increase in 2023, flat Fed funds through October of 2024, and ends 2024 approximately 75 basis points higher than the forward curve. With the move and rates higher, we now anticipate net interest margin for the fourth quarter to be around 305 basis points to 310 basis points.

This is 5 basis points 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 2023 endpoint. Turning to Slide 12. 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. As we have noted in the past, where beta ultimately tops out will be a function of the endgame 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 three 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 to 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. The construct of our balance sheet is approximately half fully variable rate, 10% indirect auto, which is a shorter, approximately two-year duration fixed product, 10% in arms with a five-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, 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 billion and has grown quarter-over-quarter.

At quarter end, this pool of available liquidity represented 204% of total uninsured deposits appear leading coverage. 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-fix swaption strategy, which increased by $5.9 billion during the quarter to $15.5 billion 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. We also added $2 billion in [callers] (ph) to support our NIM against longer term down-rate scenarios.

Moving on to Slide 17. GAAP non-interest income increased by $14 million, or 2.8%, to $509 million for the third quarter. Excluding the mark to market on the pay-fix swaptions, fees were relatively stable quarter-over-quarter. On an underlying basis compared to the second quarter, we saw increases in deposit service charges, including higher payment-related treasury management fees. 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 six years, benefits from a broad set of capabilities bolstered by Capstone. 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.

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 million and underlying core expenses increased by $25 million. As I mentioned, we incurred $15 million 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.

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 four revenue segments to two, and 31 branch consolidations. Now in the third quarter, 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.

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 four quarters. OCI impacts to common equity Tier 1 resulted in an adjusted CET1 ratio of 8%. 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 between 20 basis points and 30 basis points. This level continues to be at the low end of our target through the cycle range for net charge-offs of 25 basis points to 45 basis points. 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% of total loans, and our ACL coverage ratio is amongst the highest in our peer group.

Let’s turn to our outlook for the fourth quarter on Slide 22. We forecast loan growth of approximately 1% in the fourth quarter, which would put full-year loan growth at approximately 5%, matching the lower end of our prior range. Deposits are likewise expected to grow in the fourth quarter by approximately 1%. Core net interest income for the fourth quarter is expected to decline between 4% and 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% and 5% into the fourth 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 basis points to 30 basis points guidance range. Finally, let me close on slide 23 with a few thoughts on our management priorities for 2024. We’re still finalizing our budget for next year, and as always, we look to share more specific guidance during our January earnings call. First 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 of strength, and we expect to maintain that position as we get ahead of proposed capital regulations and phase-in periods. Related to deposits, we are continuing to acquire and deepen primary bank customer relationships.

This should result in continued growth of deposits into next year, while supporting our discipline management of deposit beta. 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 and then interest income dollars on a full year basis. Non-interest income remains a critical focus for us, with sustained execution on three primary strategic areas for fee revenue growth: capital markets, payments, and wealth management. Over the medium term, we expect that noninterest 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. 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. 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&A. Tim, over to you.

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

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Q&A Session

Operator: Thank you. At this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Thank you. And our first question is from the line of Manan Gosalia with Morgan Stanley. Please proceed with your question.

Manan Gosalia: Hi, good morning.

Steve Steinour: Good morning, Manan.

Manan Gosalia: Can you talk about the puts and takes in that 4% expense growth number for next year? What sort of revenue environment is that baken? 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?

Zach Wasserman: Yep, 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. We’re one of the most efficient banks in the regional banking space, and that’s been a product of years of efforts. 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 level up with growth given the overall revenue environment. But also in the medium term, we see significant growth opportunities over time for Huntington. And we want to 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 $0.5 billion of annual expense saves from the TCF merger. Over the last year since then, we’ve felt underlying core expenses to 2.4%. And we did that with all the programs I’ve just talked about in prepared remarks. The long-term efficiency programs, proactive actions we took in the first quarter of this year, and now a new set of actions that we’re implementing in the third quarter, 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.

And as we look at the 2024, 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 fee 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, C-CAR, resolution finding, and ultimately enhance our risk management, so we can operate from a position of strength just as we are right now going forward, which will require investment. So the kind of things that are driving that roughly 1.5% higher run rate are invested 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, if I 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 ensuring that Huntington continues to be in the position of strength to go forward.

Steve Steinour: This is Steve. Just to sort of come in over top of that, we think this is the 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 colleagues, more talent, if you will. We’ll have some new capabilities, all of which are in the plan and the numbers Zach shared with you.

Manan Gosalia: 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?

Steve Steinour: It’s a little [indiscernible] to give you precise guidance on that, but driving toward operating leverage over time is a key element of our goals. You’ll remember that is our three major financial targets we’ve 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 managing for the median 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. Talked about operating numbers over time will absolutely be part of the plan. And we’ll have to see the precise outlook for 2024 going forward and to quantify that in more specific ways.

Manan Gosalia: Appreciate the detailed answers. Thank you.

Operator: Our next question is from the line of John Pancari with Evercore ISI. Please proceed with your question.

John Pancari: Good morning.

Steve Steinour: Good morning, John.

John Pancari: Just on the net interest income front, I know you indicated that you implied — you expect a trough in the fourth quarter and then expanding through 2024. Maybe can you help us frame the magnitude of growth that 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 size that up in terms of what’s a fair assumption based on what you’re looking at.

Zach Wasserman: Yep, that’s a great question. This is Zach. I’ll take that one. I think just to take a step back, we saw in the third quarter really highlighted the effectiveness of our overall asset sensitivity management program. We saw NIM expand and the benefits of asset-required pricing really coming through into a stronger NIM. What we saw in the third quarter was about 10 basis points increase in NIM from the second quarter. Around half of that, I will note, are items that were temporary in nature, reducing Fed cash in Q3 from Q2, drove around 3 basis points, we’ve 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 third quarter, as I noted.

As we think about Q4, our expectation is to have to see a NIM of between 305 basis points and 310 basis points, which is around 5 basis points 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’ve 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 the dollars of NII in Q4 will be down around 4% to 5% from Q3 and informing a trough both in NIM ratio and the NIM and net interest income dollars in the fourth quarter then trending higher from there. The NIM outlook for 2024, I expect to be flat to rising, as I noted.