Huntington Bancshares Inc

NASDAQ:HBAN

Earnings Call Transcript 2019-Q2

[Operator]

Greetings and welcome to the Huntington Bancshares second quarter earnings call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mark Muth, Director of Investor Relations. Thank you. You may begin.

[Mark Muth, Director, IR]

Thank you, Sherri. Welcome. I'm Mark Muth, Director of Investor Relations for Huntington. Copies of the slides we'll be reviewing can be found on the Investor Relations section of our website, www.huntington.com. This call is being recorded and will be available as a rebroadcast starting about 1 hour from the close of the call. Our presenters today are Mac McCullough, Chief Financial Officer; and Rich Pohle, Chief Credit Officer. Unfortunately, Huntington's Chairman, President and CEO, Steve Steinour, is unable to join us today.

Earlier this week, while training for the upcoming Pelotonia charity bike ride, Steve injured his shoulder, requiring surgery, and that has prevented his participation in our second quarter earnings call today. He's already on the mend and expected to return to work in the coming days.

As noted on slide two, today's discussion, including the Q&A period, will contain forward-looking statements. Such statements are based on information and assumptions available at this time and are subject to changes, risks and uncertainties, which may cause actual results to differ materially. We assume no obligation to update such statements. For a complete discussion of risks and uncertainties, please refer to this slide and materials filed with the SEC, including our most recent Forms 10-K, 10-Q and 8-K filings. Let me now turn it over to Mac.

[Mac McCullough, CFO]

Thanks, Mark, and thank you to everyone for joining the call today. As always, we appreciate your interest and support. We had a solid second quarter, reporting net income of $364 million, an increase of 3% from the year ago quarter. Earnings per common share were up $0.33, up 10% from the year ago quarter. Tangible book value per share ended the quarter at $7.97, also a 10% year-over-year increase. Our profitability ratios remain strong as our return on tangible common equity was 18%, and our return on assets was 1.36%. Total revenue increased 6% year-over-year.

Average loans increased 4% year-over-year, including a 5% increase in consumer loans and a 4% increase in commercial loans. Average core deposits increased 4% year-over-year as we continue to fully fund loan growth with core deposits. Overall asset quality remained strong as most credit ratios remained near cyclical lows.

As we guided to on the first quarter earnings conference call, net charge-offs declined this quarter back to a level below the low end of our average through-the-cycle target range of 35 to 55 basis points. As we have noted previously, we expect some quarter-to-quarter volatility given the very low loss and problem loan levels at which we are operating. Our ratios for nonperforming assets, delinquencies and criticized loans all remain very good.

As briefly outlined on slide three, we developed Huntington strategies with a vision of creating a high-performing regional bank and delivering top quartile through-the-cycle shareholder returns. We continue to make profitable and meaningful long-term investments in our business, particularly around customer experience, to drive organic growth. This quarter, we were pleased to receive an important independent confirmation of our digital technology investments and our customer experience focused strategy with two awards from J.D. Power, the gold standard of customer satisfaction surveys in the U.S. Huntington received the highest scores in both the J.D.

Power 2019 U.S. online banking and mobile app satisfaction studies. While some expressed skepticism that regional banks will be able to keep up with the large money center banks and a technology-driven economy, we believe this provides evidence that our focused technology investments and our strategy provide Huntington not just the opportunity to keep up but to remain industry-leading in our client acquisition and our customer satisfaction. We also prudently allocate our capital to ensure we are earning adequate returns and taking appropriate risk, consistent with our aggregate moderate-to-low risk appetite.

This quarter, we took several actions to better position the balance sheet from an interest rate management perspective but also with respect to overall risk and return. We exited certain loans and high-cost deposit relationships which no longer met our return hurdles, and we repositioned a portion of the securities portfolio.

I will discuss these actions in more detail in a few minutes. We are very pleased with how we are positioned. We have built sustainable competitive advantages in our key businesses that we believe are delivering and will continue to deliver top quartile financial performance in the future. We remain focused on driving sustained, long-term financial performance for our shareholders.

Slide four illustrates our updated expectations for full year 2019 compared to our prior expectations. As you know, we previously provided our expectations assuming no change in short-term interest rates. However, this quarter, we are transitioning to provide our expectations based on the implied forward curve, which are provided in the column on the right side.

Given the high likelihood that the Fed will reduce the Fed funds target rate at their meeting next week and the market expectations for multiple additional rate cuts over the coming year, we thought it was more conservative to adopt this interest rate outlook in our planning and forecasting process internally as well as externally in the expectations we communicate to you. We also have provided an unchanged rate view in the middle column on the slide.

This quarter, we provided both interest rate scenarios so you can see the incremental steps between the two but do not plan to provide both views going forward. For the remainder of 2019, we intend to only provide expectations based on the implied forward rate scenario. Our view of the economy has not changed since last quarter's earnings call. We continue to have a constructive view of the local economies in our footprint, which we expect will translate into continued organic growth this year.

While the volatility in the debt markets has signaled street concerns regarding the broader economy, what we are hearing from our customers remains positive. Businesses in our local markets generally continue to deliver good performance, and our commercial pipelines remain strong.

Businesses in our footprint are investing in capital expenditures and expansions while the tight labor markets continue to constrain economic growth. Our commercial customers continue to tell us that finding employees is their biggest challenge. The job openings rate for the Midwest is the highest in the nation. Some of these businesses also have weathered the headwinds of ongoing tariff and trade disputes. Despite a slowing world economy and these headwinds, the data shows that exports have continued to grow in Ohio and other areas of our region. Across our footprint, consumers also remain upbeat with strong labor markets driving wage inflation, particularly at the lower compensation levels.

In the 3 months ending May of 2019 and the 12 months ending May of 2019, unemployment rates declined in 18 of 20 of the largest MSAs in Huntington's footprint states. Additionally, consumer confidence in our regions generally stayed at the highest levels since 2000. Job openings continue to exceed unemployment levels in most of our markets. I would summarize by saying that we remain bullish in the economy and our footprint.

As I have stated on several occasions this year, we do not see signs of a near-term economic downturn. Nonetheless, we are cognizant of the recent market volatility and global economic data that does not share the optimism of what we are seeing here in the Midwest. These ultimately could drive the Fed to adjust short-term interest rates lower.

As we communicated on the last earnings call, we have taken steps to prepare for a more challenging interest rate outlook. We do not foresee a recession in the near term. However, our core earnings power, strong capital, aggregate moderate-to-low risk appetite and our long-term strategic alignment position us to withstand economic headwinds. Our strategy is designed to drive more consistent performance across economic cycles. Let's turn to our revised full year 2019 expectations. We have modestly reduced our balance sheet growth expectations reflecting the balance sheet optimization efforts from the second quarter and a more competitive operating environment at the margin.

We expect full year average loan growth in the range of 4% to 5% and full year average deposit growth in the range of 2% to 3%. We remain particularly focused on growing core deposits through acquiring core checking accounts and deepening customer relationships. We expect full year revenue growth of 3% to 4.5%. On a GAAP basis, full year 2018 NIM -- sorry, 2019 NIM is expected to be 3.25% to 3.30% range.

This includes the negative impacts from the anticipated reduction in the benefit of purchase accounting and the cost of the incremental hedging strategy we implemented in the second quarter. Looking further out, our current modeling suggests that NIM will bottom out during the second half of 2019. As a result, we currently expect full year 2020 NIM should relatively consistent with full year 2019, allowing net interest income to grow in tandem with earning asset growth next year.

As we have told you previously and are demonstrating with our actions, we remain committed to delivering positive operating leverage this year. We have moderated the expense growth outlook for 2019 in conjunction with the reduced revenue growth outlook. We have achieved this with a combination of reductions to discretionary spending and with the repacing of planned investments.

Full year 2019 noninterest expense is now expected to increase 1% to 2.5%. We anticipate that full year 2019 net charge-offs will remain below our average through-the-cycle target range of 35 to 55 basis points. Our expectation for the effective tax rate for the remainder of the year is in the 15.5% to 16.5% range. Slide five provides the highlights for the 2019 second quarter.

Results reflected strong earnings momentum with double-digit growth rates in earnings per common share and tangible book value per share along with continuing improvement in our profitability ratios. We recorded net income of $364 million, an increase of 3% versus the year ago quarter. We reported earnings per common share of $0.33, up 10% year-over-year and tangible book value per common share ended the quarter at $7.97, a 10% year-over-year increase. Return on assets was 1.36%, return on common equity, 14% and return on tangible common equity was 18%. Our efficiency ratio for the quarter was 57.6%, up from 56.6% in the year ago quarter.

And again, we reminded you in the first quarter call that the second quarter would be the peak efficiency ratio for the year. This modest increase reflects continued thoughtful investments in our colleagues and technology. For the full year, we continue to expect modest year-over-year improvement in our efficiency ratio consistent with driving annual positive operating leverage. Turning now to slide six. Average earning assets increased to $2.8 billion or 3% compared to the year ago quarter. Loan growth accounted for more than the entire increase as average loans and leases increased $3 billion or 4% year-over-year including a $1.7 billion or 5% increase in consumer loans and a $1.3 billion or 4% increase in commercial loans.

Average commercial and industrial loans grew 6% from the year ago quarter and reflected the largest component of our year-over-year loan growth. C&I loan growth has been well diversified over the past year with notable growth in corporate banking, asset finance, dealer floor plan and middle market banking. We also continue to see good early traction in our new specialty lending verticals that were announced as part of the 2018 strategic plan. Alternatively, we continue to actively manage our commercial real estate portfolio around current levels with average CRE loans reflecting a 6% year-over-year decline.

This reflects both anticipated and unanticipated pay downs as well as our strategic tightening of commercial real estate lending to ensure appropriate returns on capital and to manage risk. During the second quarter, we exited approximately $400 million of our commercial loans at renewal or through loan sales as part of our balance sheet optimization efforts.

These loans no longer met our return hurdles and their exit allowed us to redeploy the associated funding into more attractive opportunities. Consumer loan growth remained centered in the residential mortgage and RV and marine portfolios, reflecting the well-managed expansion of these 2 businesses since the FirstMerit parent acquisition. Average residential mortgage loans increased 14% year-over-year.

As we typically do, we sold agency-qualified mortgage production in the quarter and generally retained jumbo mortgages and specialty mortgage products. Average RV and marine loans increased 28% year-over-year as we continue to gain traction and market share across the 34-state footprint for this business. Average auto loans were flat year-over-year. Originations totaled $1.3 billion for the second quarter, down 19% year-over-year. As we have previously mentioned, we are executing a pricing strategy to optimize revenue via increased auto loan pricing that has resulted in lower production volumes, but that is a trade-off we like.

New money yields on our auto originations averaged 4.63% during the second quarter, up 41 basis points from the year ago quarter. Over the past few weeks, new money yields in both auto and RV/marine have come under some pressure due to the year-to-date movements in the 2- the 5-year portion of the yield curve and increased competition. Finally, securities were down 4% year-over-year as we let the portfolio run off and utilized the cash flow to fund higher-yielding loans during 2019.

During the 2019 second quarter, we sold 1 billion of securities as part of the balance sheet optimization efforts to reduce our reliance on short-term wholesale funding, repurchased $600 million of securities related to the hedging program, and late in the quarter, we remixed approximately $500 million of securities at a net benefit of approximately 20 basis points.

Turning to slide seven. Average total deposits grew 3% year-over-year while average core deposits grew 4% year-over-year. Average money market deposits increased 11% year-over-year reflecting the shift in promotional pricing away from CDs to consumer money market accounts in mid-2018. Core certificates of deposit were up 54% from the year ago quarter primarily reflecting the consumer CD growth initiatives during the first 3 quarters of 2018. Average interest-bearing DDA deposits increased 3% year-over-year while average noninterest-bearing DDA deposits decreased 3%. Average total demand deposits were flat year-over-year.

As shown on slide 32 in the appendix, we are very pleased that our consumer noninterest-bearing deposits increased 5% year-over-year as we continue to grow households and deepen relationships. We continue to see our commercial customers shift balances from noninterest-bearing DDA to interest-bearing products, primarily interest checking, hybrid checking and money market.

Average savings and other domestic deposits decreased 9% primarily reflecting a continued shift in consumer product mix, particularly among legacy FirstMerit accounts as FirstMerit's promotional pricing strategy is focused on savings accounts compared to our primary focus on money market accounts. Importantly, our continued focus on core funding allowed for a 23% year-over-year reduction in noncore deposits.

Moving down to slide eight. FTE net interest income increased $28 million or 4% versus the year ago quarter primarily driven by the 3% increase in average earning assets. We saw net interest margin expansion of 2 basis points to 3.31% compared to the 2018 second quarter as a result of disciplined asset and deposit pricing and the benefit of interest rate increases partially offset by the continued runoff of purchase accounting accretion. Moving to slide nine. Our core net interest margin for the second quarter was 3.26%, up 4 basis points from the year ago quarter. Purchase accounting accretion contributed 5 basis points to the net interest margin in the current quarter compared to 8 basis points in the year ago quarter.

Slide 28 in the appendix provides information regarding the actual and scheduled impact of the FirstMerit purchase accounting accretion for 2019 and 2020. Turning to the earning asset yields. Our commercial loan yields increased 30 basis points year-over-year while consumer loan yields increased 33 basis points. Securities yields increased eight basis points. Our deposit costs remained well contained with the rate paid on total interest-bearing deposits of 97 basis points for the quarter, up 38 basis points year-over-year and up just three basis points sequentially. I might add that we expect total interest-bearing deposit costs to decline in both the third and the fourth quarters of 2019.

Turning to slide 10. On a sequential basis, the GAAP NIM compressed 8 basis points and the core NIM compressed 7 basis points. The lower and inverted yield curve included the impact on LIBOR rates, accounted for approximately 3 basis points of the NIM compression, while the continued lift in deposit cost drove 2 basis points. The incremental hedging strategy implemented in the second quarter compressed the NIM by 1 basis point and is also expected to have a negative 1 basis point impact on the full year 2019 NIM, modestly better than the guidance we provided at an industry conference in May.

Turning to slide 11. Slide 11 provides an update to a slide we presented at an industry conference during the second quarter that summarizes the incremental hedging strategy to reduce the downside risk from lower interest rates. The incremental hedges include both asset swaps and floors. We have now substantially completed implementation of the incremental hedges. However, as you should expect, we will continue to fine-tune the overall hedging program as the interest rate environment, balance sheet mix and other factors necessitate. It's also important to remember that we've had the cost of the hedging program, including the incremental hedging executed in the second quarter, in our guidance since late 2018.

Turning to slide 12. Slide 12 illustrates our cycle-to-date interest-bearing deposit beta compared to peers. Our cumulative deposit beta remains low at 33%. We have been communicating that we believe the consumer core CD strategies we utilized over the first three quarters of 2018 would serve us well over time, effectively front-loading some of the deposit beta. You can see those benefits over the past 3 quarters as our cumulative data has not increased as quickly as peers and is now below the peer average. This quarter, the peer group's average cumulative beta increased 4% while we saw a 1% increase in our cumulative beta.

Overall, commercial deposit competition was elevated throughout the second quarter, and competition for consumer deposits to date has not yet retrenched as much as expected despite the likely Fed rate cuts next week. Given this competitive environment and the near-term rate outlook, we've maintained our pricing discipline and shortened our promotional pricing terms such as utilizing a 6-month money market promotional rate compared to a 12-month promotion common in the marketplace. We also chose to fund loan growth through the securities sales that I mentioned earlier rather than paying up for high-cost commercial deposits.

Looking forward, we have developed strategies down to the customer level to quickly react, particularly along our highest-cost deposits should the Fed cut rates next year -- next week as expected. We have also approximately $3 billion of securities in excess of what is needed for LCR that we could use as a funding source should market deposit pricing become unattractive. Slide 13 provides detail on our noninterest income, which increased 11% from the year ago quarter. Other noninterest income increased 48% year-over-year primarily due to the $15 million gain on the sale of our Wisconsin retail branches as well as the $5 million mark-to-market adjustment on economic hedges.

Subsequent to quarter end, we redesignated all the economic hedges as cash flow hedges. So beginning in 3Q of '19, all the swaps and floors will be accounted for as cash flow hedges. Capital market fees were up 31% versus the year ago quarter primarily reflecting the acquisition of Hutchinson, Shockey and Erley in the 2018 fourth quarter. Mortgage banking income increased 21% primarily reflecting higher secondary market spreads. On a linked quarter basis, mortgage banking income also benefited from seasonality and, to a lesser extent, lower mortgage interest rates during the quarter.

Slide 14 provides the components of the 7% year-over-year growth in noninterest expense. As we mentioned on the last earnings call, we expected noninterest expense to increase $40 million to $50 million linked quarter, with 2/3 of that coming from normal seasonality and compensation expense as a result of the annual grant of our long-term incentive compensation in May as well as the May implementation of annual merit increases. Personnel expense increased 8% year-over-year primarily reflecting these actions. Further increasing personnel expense year-over-year was the continued hiring of experienced bankers in our new lending verticals as well as adding colleagues in our digital and technology areas related to the 2018 strategic plan initiatives.

Outside data processing and other services increased 29% year-over-year driven by ongoing technology investment costs. Other noninterest expense increased 24% primarily reflecting a $5 million donation to the Columbus Foundation and the impact of new lease accounting standards on personal property tax expense. Partially offsetting these increases, deposit and other insurance expense decreased 56% due to the discontinuation of the FDI surcharge in the 2018 fourth quarter. Slide 15 illustrates the continued strength of our capital ratios. The tangible common equity ratio ended the quarter at 7.80%, up 2 basis points from the year ago quarter.

The common equity Tier 1 ratio ended the quarter at 9.88%, down 65% year-over-year but up 4 basis points linked quarter. We continue to manage CET1 within our 9% to 10% operating guideline with a bias towards the operating end of the range. We repurchased 71.8 million common shares over the last 4 quarters. During the 2019 second quarter, we repurchased 11.3 million common shares at an average cost of $13.40 per share, representing the remaining $152 million of common stock repurchase authorization in the 2018 capital plan.

As we announced last month, our 2019 capital plan reflects our previously articulated priorities to fund organic growth first; to support the cash dividend second; and third, to pursue all other capital uses including buybacks. These capital priorities have not changed. The 2019 capital plan includes a 7% increase in the quarterly dividend rate to $0.15 per share beginning with the dividend that the Board declared last week and payable in October. Last week, the Board also approved a new authorization for the repurchase of up to 513 million of common shares over the next 4 quarters.

Let me now turn it over to Rich to cover slide 16 with the credit trends for the quarter. Rich?

[Rich Pohle, Chief Credit Officer]

Thanks, Mac. Slide 16 provides a snapshot of key quality metrics for the quarter, which remain strong. Consistent prudent credit underwriting is one of Huntington's core principles, and our financial results continue to reflect our disciplined approach to risk management and our aggregate moderate-to-low risk appetite. We booked loan loss provision expense of $58 million in the second quarter and net charge-offs of $48 million. Our provision expense has not exceeded net charge-offs in 6 of the past 7 quarters, illustrating our high-quality earnings.

Net charge-offs represented an annualized 25 basis points of average loans and leases in the current quarter, up from 16 basis points in the year ago quarter and, as expected, down from 38 basis points in the prior quarter. There is additional granularity on charge-offs by portfolio in the analyst package on the slides, and there was no industry concentration to speak of. The allowance for loan and lease losses, or ALLL, as a percentage of loans remained relatively stable at 1.03%, up 1 basis point linked quarter.

The nonperforming asset ratio remained flat linked quarter and increased 4 basis points year-over-year to 61 basis points. The year-over-year increases was centered in the C&I portfolio partially offset by decreases in the commercial real estate, residential mortgage and home equity portfolios. There was also a year-over-year increase in other NPAs associated with the investment portfolio. Overall, asset quality metrics remain near cyclical bests. And as we have noted previously, some quarterly volatility is expected given the absolute low level of problem loans.

I'll now turn it back to Mac for some closing remarks.

[Mac McCullough, CFO]

Thanks, Rich. Slide 17 highlights the actions we have taken since 2009 resulting in our current industry-leading profitability metrics. Our 14% return on common equity and 18% return on tangible common equity positions Huntington as a top-performing regional bank. We are building a best-in-class return profile at Huntington, and we are excited about the opportunities that this creates.

Let me turn it back over to Mark so we can get to your questions.

[Mark Muth, Director, IR]

Thanks, Mac. Sherri. We will now take questions. [Operator Instructions] Thank you.

[Operator]

[Operator Instructions] Our first question is from Scott Siefers with Sandler O'Neill. Please proceed.

[Scott Siefers, Sandler O'Neill]

Hey, good morning guys. Thanks for taking the question. Mac, I just wanted to ask a little about the margin guidance. So I guess first of all, just appreciate the commentary with both the just the flat rate and the implied forward curve. That's helpful, so thank you for that.

But then just as you look at the anticipated contraction in the margin for the second half of the year, just given that it implies some severe contraction in the back half, I wonder if you could just walk through what the main nuances would be that would allow you to come in toward the higher end versus the lower end. In other words, how do we get to the median part of the range?

[Mac McCullough, CFO]

Yes, Scott. I think the wild card of the mix is going to be what happens with core deposit growth and the cost of core deposits. Right now, we're very pleased with the growth that we're seeing. We're being selective in terms of the commercial deposits and paying up for commercial deposits, but we're seeing good growth on the consumer side. And I would tell you that competition in our region is rational. As I mentioned in the script, we have taken our deposit strategy and tactics to a different place relative to the peers.

We've become, I think, less aggressive in terms of incremental pricing as we enter this lower-rate environment, but we're comfortable with that just given some of the strength we see on the consumer deposit side but also the excess liquidity that we have in terms of being able to release securities and use that funding to basically put higher-margin loans on the balance sheet. So it's really the cost of deposits and the deposits got a growth in the second half, but I'm confident that we're well positioned for that.

[Scott Siefers, Sandler O'Neill]

Okay. Perfect. And then just separately, so expenses will have to come down fairly meaningfully in the second half of the year. I know there was a lot of seasonality that hit the second quarter numbers. So presumably, there's some relief in sight. But just wondering if you could talk for a second about kind of the puts and takes on the cost side as we enter the second half of the year, please.

[Mac McCullough, CFO]

Yes. Sure. So we've been, I think, pretty transparent around the opportunities that we have to adjust our expense growth in 2019 for the revenue environments and what we see happening with interest rates going forward. We've started to take those actions. A lot of the expense growth in 2019 has come out of strategic initiatives that we put in place in 2018 through the strategic planning process. We've deferred some of those investments.

However, we are continuing to make investments and the initiatives that we think are most beneficial from our revenue growth or risk perspective or just thinking about what we need to do from technology development, particularly in digital.

Those investments are still on the table. So we've been, I think, appropriately prudent in terms of the investments that we're continuing with, and there's always the likelihood that the rate environment turns out better than what is being foreshadowed right now that we would put more of those investments back on the table. So we believe we've got the capability to manage the positive operating leverage in 2019. And certainly for 2020, it's going to depend on where the revenue environment goes, but we still have expense levers that we can pull.

[Scott Siefers, Sandler O'Neill]

Okay that's perfect. Thank you very much Mac, I appreciate it.

[Operator]

Our next question is from Jon Arfstrom with RBC Capital Markets. Please proceed.

[Jon Arfstrom, RBC Capital Markets]

Thanks, good morning guys.

[Mac McCullough, CFO]

Good morning Jon.

[Jon Arfstrom, RBC Capital Markets]

The question a little bit about commercial lending. You talked about the exit of 400 million commercial balances. I don't know if it's for you, Rich, but curious, can we expect more of that? And can you maybe talk about some of the primary reasons behind some of those decisions?

[Rich Pohle, Chief Credit Officer]

Yes. Jon, it's Rich. I think a lot of the decision on the 400 million was just around rate and yield. And as we looked to optimize the balance sheet, I think we focused on low-yielding assets that may not have been part of the primary bank relationship that really just didn't make sense to continue moving forward on. So I would say that we're going to continue to look at customer profitability going forward.

And to the extent that we have borrowers that don't meet our relationships, we'll look to make adjustments, either try to strengthen that relationship and make it more profitable or look to exit. So I think Q2 had a fair number exits in there, and I would say it's just a continuing process going forward as we focus on the balance sheet and where we can be most profitable.

[Mac McCullough, CFO]

Yes. Jon, it's Mac. So I might add, this is the play that we ran in 2017 with great success. We -- I think when we did this in 2017, we picked up about 41 basis points of CET1. So we do this on a regular basis. We're always looking at the balance sheet at a very granular level. And in this environment, we just think it's a prudent thing to do to make sure that our capital is working hard and that we're putting ourselves in the position to fund the balance sheet and get the right returns in this environment.

[Jon Arfstrom, RBC Capital Markets]

Okay. It make sense. And I guess that goes to my next follow-up here is just the loan growth numbers. You took in the -- it's very subtle and modest, but you took in a higher range of loan growth range and also deposits, and can you just maybe talk a little bit about that, the purpose of that?

[Mac McCullough, CFO]

Yes. So part of it is the -- what we continue to do from an auto perspective. We continue to price for profitability as opposed to the volume, so that continues to be the play that we're running. And I think we just became on the margin a bit more conservative in terms of what we would expect from growth on the loan side in 2019, not because the pipelines are in worse shape because they're actually in really good shape, but I think the mood here is just one of caution and just making sure that we're careful and we put on the balance sheet what we feel comfortable with.

But from a deposit perspective, it has everything to do with the tactics that we're taking in the marketplace where we're leading the market down from a CD perspective -- CD pricing perspective and also the tactics that we're using to raise money market deposits. We're using a 6-month guaranteed term on rate, and the market is still at a 12-month. So we do expect that this will have some incremental impact on deposit growth, but we're fine with that. As I mentioned, we've got the excess liquidity that we can always fall back on.

And I guess the other part of that is just commercial deposit pricing and not wanting to pay up for deposits in this environment. We certainly take a look at the relationships, as Rich mentioned. And to the extent it's a deep relationship or a potential for a deep relationship, we certainly work with the client. But I have no interest in $100 million with no other relationship and paying up for that deposit at this point in time. So the growth rates reflect those tactics and strategies.

[Jon Arfstrom, RBC Capital Markets]

Okay, all right, thanks guys.

[Operator]

Our next question is from Brian Foran with Autonomous Research. Please proceed.

[Brian Foran, Autonomous Research]

Hey, good morning. I wish I had $100 million deposit, to give you.

[Mac McCullough, CFO]

The largely you brought other products along with that we'd be fine.

[Brian Foran, Autonomous Research]

The, so on the NIM, you kind of talked about the bottoming in the second half of '19 and I think you said stable in 2020. And I just wanted to clarify are you talking the stable relative to the 3.25% to 3.30% full year range? Or are you thinking more stable to whatever the fourth quarter exit run rate NIM is?

[Mac McCullough, CFO]

Yes. Brian, that's a great question. This was full year 2019 NIM of 3.25% to 3.30%. We expect it to be stable in 2020 in that range.

[Brian Foran, Autonomous Research]

And I mean I guess that seems to imply a little bit of a bounce back up in 2020. Is it deposit pricing catch-up? Or what would kind of make the 2020 NIM maybe slightly higher than the fourth quarter exit for the year?

[Mac McCullough, CFO]

Yes. As you might expect, deposit pricing is going to have a bit of a lag to it. So we actually see the largest benefit from -- well, we expect from a deposit pricing perspective in the fourth quarter of 2019, and that will continue into 2020 along with the impacts of the hedge program. Assuming we get the implied forward curve the way it is currently forecast, the hedge program will kick in and give us some incremental margin to help offset what's happened in the rate environment.

[Mark Muth, Director, IR]

Brian, this is Mark. Remember, the CD campaign last year and the first 3 quarters, those all mature beginning in the third quarter. So as those roll off, we're assuming they'll reprice down nicely.

[Brian Foran, Autonomous Research]

And if I could sneak in one less clarification or expansion, I think you mentioned July auto pricing competition might have picked up a little bit. Can you just maybe give a little bit more color on what you saw there?

[Mac McCullough, CFO]

Yes. We've been pretty consistent in terms of raising pricing in the marketplace. It's been a good play for us. We typically see the competition follow. But in this environment, as we had some of the higher rates out, we felt that maybe we weren't getting the right type of customer, maybe a slight deterioration in some of the credit metrics. And so we quickly changed the pricing strategy, and everything fell back into place the way we would expect to see it. But that is the barometer that we use.

I mean we have a box for credit on the auto book that we don't move outside of. And we change pricing based upon what we see happening, and that, of course, takes into consideration many factors, what's happening in the marketplace, what's happening with competition, what's happening with interest rates, but the one variable that we hold constant when thinking about pricing in the auto book is where we're at from a credit perspective.

[Mark Muth, Director, IR]

And on the boat and RV side, we've seen a couple of new entrants into the market and one legacy participant expand nationally, and the combination of those 3 has significantly increased pricing competition for boat and RV loans here over the last few months.

[Operator]

Our next question is from John Pancari with Evercore. Please proceed.

[John Pancari, Evercore]

Morning, regarding your 2019 to 2021 longer-term goals -- or medium-term goals, should we call it, I noticed you didn't include them in the -- in your slides or mention them. So I just wanted to see if you have any updated thoughts on those targets, particularly around the efficiency guidance of 53% to 56% and also in the ROTCE outlook for 17% to 20%.

[Mac McCullough, CFO]

Yes. No, we're still comfortable with those long-term targets. Didn't mean to signal anything by not including them in the slide deck or the presentation. So those are our targets for the next 3 to 5 years.

[John Pancari, Evercore]

Okay. Great. And then separately on the 2019 revenue outlook of 3% to 4.5%, can you give us a little bit more detail how that would break out between spread revenue and fees? And then also, has your fee income outlook changed at all? And if so, what is changing that view?

[Mac McCullough, CFO]

Yes. So we're having a really good year on the fee side. Capital markets continues to perform very well. We're making smart investments in that business. We've got a terrific team and a really good opportunity across the franchise, in particular when you think about the FirstMerit legacy customers and some of the capabilities that we bring to that customer base. We still have opportunities as it relates to capital markets products and being able to have deeper relationships with those customers. We got a good product set, and we feel very good about the outlook for that business. It's going to continuing to grow, assuming the economy cooperates.

Treasury management is another place for us that we feel very good with the momentum and what we're seeing in the field. In particular, we're seeing some new product capabilities in the business banking space that is actually producing some incremental growth that we expected and excited to see developing. So that's a category that works for us as well. And then mortgage, we do expect that we're going to have continued good results in 2019. We're going to continue to see good refinance opportunities, and the secondary marketing spread has actually improved as well so that helps.

And then we continue to grow households. I mean we're continuing to grow consumer households. We're continuing to see deposit service charges increase in conjunction with that household growth, and we're getting good deposit growth out of that expansion in households as well. So the growth in 2019 is going to be weighted more on a percentage basis to fee income, which is partially some of the strength in the categories that I mentioned but also the rate environment and what's happening to the -- for the NIM. But very excited about the momentum we have on the fee side.

[John Pancari, Evercore]

Okay. So that 3% to 4.5% revenue outlook for '19, that did come down, but that was mainly all spread income then, correct?

[Mac McCullough, CFO]

That would be correct, yes.

[John Pancari, Evercore]

Got it. All right, thanks, Mac.

[Operator]

Our next question is from Ken Zerbe with Morgan Stanley. Please proceed.

[Ken Zerbe, Morgan Stanley]

Thank you. Hi, guys I guess my first question is in terms of the hedging that you did this quarter, accelerating your hedging. We've heard from some other banks this quarter that they did not do hedging or that they thought because the curve was pricing in a significant decline in rates, the hedging was not the right decision for them. Can you just talk about why accelerating your hedging was the right decision for Huntington and maybe differ from other banks? And what are you assuming in terms of the rate outlook from here that makes it the right choice?

[Mac McCullough, CFO]

So our implied outlook has the Fed decreasing in July and September of this year and May and October of 2020. So basically, we began the hedge program, I think, at a time when we felt the economics of putting the hedge on made sense relative to the outlook we had for the environment and what was going to happen to interest rates going forward. There certainly came a time when I would say that the benefit was fully reflected in the price of those hedges and we pulled back, but we felt that we got the program in place to the extent that it stabilized the margin going forward, which is what we were trying to accomplish.

So clearly, different of every bank in terms of where you're at from an asset liability position and the mix of your balance sheet and what you expect from growth going forward, but we feel that we kind of hit it right in terms of what we did and the impact that it's going to have on the margin going forward.

[Ken Zerbe, Morgan Stanley]

Okay. Great. And then just as a follow-up, maybe just a clarification for us, I think you mentioned all your swaps and floors next quarter are going to be considered cash flow hedges. Can you just remind us what that means and why it's better than something else?

[Mac McCullough, CFO]

So the economic hedges that we have running through fee income at this point as they get mark-to-market, we did not set those up to qualify for hedge accounting. So basically, we would match them up with, say, a commercial loan portfolio, and through that, we would get hedge accounting that would allow us to reflect the benefit or the detriment of those derivatives through the margin.

The economic hedges that we moved up into the category to get hedge accounting, they did flow through the fee income in the second quarter and I think a little bit in the first quarter as well. But basically, I'd rather have the impact in the margin. And we have the capacity to basically reflect those as qualifying for hedge accounting, and we did that actually early in the third quarter.

[Mark Muth, Director, IR]

Yes. Ken, so that $5 million mark-to-market that hit fee income this quarter, going forward, that would run through OCI instead of through the P&L.

[Operator]

Our next question is from Peter Winter with Wedbush Securities. Please proceed.

[Peter Winter, Wedbush Securities]

I was looking at the loan-to-deposit ratio and it's been creeping up a little bit, and I'm just wondering is there a certain level that you wouldn't want to see it go above.

[Mac McCullough, CFO]

Yes. Peter, we don't want that to go above 100%. That's the view that we have on that. It has been creeping up a bit. We've continued to see good asset growth. And as I've mentioned, we've been a bit more conservative in terms of pricing deposits, particularly on the commercial side. So we manage that very carefully. We obviously have levers that we can pull to manage that ratio, but that would be the limit that we would have in mind.

[Peter Winter, Wedbush Securities]

Okay. And then just on the borrowing side, I guess, the $12 billion in borrowings, I was just curious, how much is floating versus fixed rate? I just want to get an idea how much could come down in cost if -- when the Fed starts cutting rates.

[Mac McCullough, CFO]

Yes. We typically swap our debt to the floating rates, and I believe we have all the swaps to floating at this point in time.

[Peter Winter, Wedbush Securities]

Got it. That's great. Thanks, Mac.

[Mac McCullough, CFO]

Okay. Thanks, Peter.

[Operator]

Our next question is from Steven Alexopoulos with JPMorgan. Please proceed.

[Steven Alexopoulos, JPMorgan]

Given, I wanted to follow up on the NIM questions. So given how meaningful you increased the hedges in the quarter, the NIM kind of feels worse than expected. Even looking at the midpoint of the guidance implies considerable pressure in the back half. Mac, with the hedges in place what do you estimate the impact to NIM from every 25 basis point cut? I mean what's a reasonable range?

[Mac McCullough, CFO]

Yes. So 25 basis point shock would be about a $24 million annual impact, so that would be a 12-month impact after a 25 basis point shock.

[Steven Alexopoulos, JPMorgan]

Okay. That's helpful. We could work that out. Okay. And then in terms of deciding how much downward pressure to place on expense growth, is there a minimum level of positive operating leverage that you're targeting for 2019?

[Mac McCullough, CFO]

Steven, I would say that there's not a minimum level. We're -- our target is to achieve positive operating leverage. We're very cognizant and aware of the environment, and we're very careful in terms of how we think about expense opportunities. We're continuing to invest for growth even in the metrics and the numbers that I've communicated to you today, and we feel that's an important component of being able to really create value going forward as driving the top line. We're long-term shareholders.

The management team and the Board of Huntington would be in the top 10 shareholders of the company without a doubt, probably a little bit higher. So yes, they're -- it probably doesn't have the impact that you might expect to see simply because rates dropped very quickly and expectations changed very quickly. And it would've been obviously much more lucrative to put the positions on earlier, but again, we're comfortable with what we got done and feel good about how the margin is going to perform going forward.

[Steven Alexopoulos, JPMorgan]

Okay. Thanks for taking my questions.

[Operator]

Our next question is from Kevin St. Pierre with KSP Research. Please proceed.

[Kevin St. Pierre, KSP Research]

Hi, good morning. how are you doing.

[Mac McCullough, CFO]

Good.

[Kevin St. Pierre, KSP Research]

So Mac, I wanted to follow up on your comments on the customer experience and the J.D. Power awards, and THAT all sounds great. I just was wondering if you could speak to your overall mobile digital strategy. What you do in-house? What you outsource? And how that fits in with your overall branching strategy.

[Mac McCullough, CFO]

Yes, Kevin. So we've got a real focus on making sure that from a customer experience perspective, we are investing really across many different areas of the bank, but in particular digital technology, to just improve customer experience. So we view investments like this as really driving improved customer experience, customer satisfaction and trust, that's the scorecard.

We don't try to build every capability that some of the larger banks have, but we build the capabilities that we think we need that are going to drive the experience that we want for our customers. So I think that's the way we approach it, and we've allocated more and more expense every year to -- or investment every year to the digital technology and what we need to do there.

So when you think about maybe a proof point for that, we rolled The Hub out, which is our new online banking platform, probably about 8 or 9 months ago. And we believe that there's a direct correlation between the vision that we have for what we wanted to try to accomplish, which was all focused on customer experience and customer satisfaction, and what we delivered with The Hub we feel actually resulted in the J.D. Power awards that we just won.

So again, we don't invest in technology for technology's sake. We invest in technology to make sure that we further our strategy and our differentiation around customer experience, and I think we got a good proof point this quarter with the J.D. Power award.

[Kevin St. Pierre, KSP Research]

Great. And then do you have any sense how you're doing with millennials versus older customers?

[Mac McCullough, CFO]

We believe that we're making progress there, and I will tell you it is a real focus of ours. Clearly, we have some proof points that we believe the millennials enjoy The Hub in terms of what we deliver, and it is a focus for us. I mean, clearly, when you think about who is more likely to be changing accounts or changing banks, it's likely going to be the younger generation. And we need to have the digital capabilities that will attract them and make them feel like we're the bank for them, and that is exactly what we're trying to accomplish. So I think we continue to make good progress there.

[Kevin St. Pierre, KSP Research]

Great, thank you.

[Mac McCullough, CFO]

Thanks Kevin.

[Operator]

Our next question is from Ken Usdin with Jefferies. Please proceed.

[Ken Usdin, Jefferies]

Hi, thanks, good morning guys. Mac, on the optimization that you've been doing in the loan and securities portfolio, how much more work do you still have ahead there that you're aiming to accomplish? Or did you get effectively what you wanted to do done in the second quarter? And how do you think about, like, what buckets that would still come from if there's more?

[Mac McCullough, CFO]

Yes. So clearly, we still have opportunity on the securities portfolio if we decided to go down that path. We think we have up to $3 billion of securities that we could take off the sheet to provide incremental funding if we go down that path. What I would tell you on the loan side is that we likely still have opportunity there. We do a lot of the work today on Excel spreadsheets and some other tools that we have to help us understand relationship profitability, but we're implementing a new application later this year that will allow us to do this in real time and actually start to have better information for relationship managers around the depth of their relationship and the profitability of their relationship and their efficiency around capital usage.

So I do expect that we're going to continue to get better at this. I do think we're going to find additional opportunities. Our first preference is always to deepen the relationship and make sure that we get to a level of profitability that reflects the capital that we're allocating to that customer. But we're going to manage this appropriately, and we're going to get the right returns for our shareholders.

[Ken Usdin, Jefferies]

Okay. And then just one on credit to follow up on that. So you had previously mentioned a need to rebuild the reserve. Credit is remaining very good. You're slowing loan growth in part because of the rationalization and a little bit on the competition, as you mentioned. Do you need to -- does that change the need to build the reserve at all in terms of just what you're putting on versus what you're not and the optimization underneath?

Yes. Well...

[Mac McCullough, CFO]

Yes. Go ahead.

[Mark Muth, Director, IR]

I mean I think when we look at the reserve and where that is and what we do on a quarterly basis, I mean, there are things that we look at just beyond loan growth. I mean, certainly, that's a part of it. We look at the composition and the mix of the portfolio. There's a number of factors that go into the provision. Certainly, we have an eye towards keeping the provision level at a certain percentage of loans and NPAs and other criticized measurements. So I think we want to continue to look at the reserve quarterly and make sure that it's sufficient for today and going forward.

[Ken Usdin, Jefferies]

Okay, thanks guys.

[Operator]

Our next question is from Brock Vandervliet with UBS. Please proceed.

[Brock Vandervliet, UBS]

Hi, Good morning. Great. I just wanted to actually follow on that question just to kind of square the circle here. End-of-period growth -- loan growth is virtually flat. It sounds like you're cautious going forward. You've done a bit of repositioning. Should loan growth pick up a bit in the second half? Or shouldn't we expect that?

[Mac McCullough, CFO]

No. I think you'll see loan growth pick up in the second half. I mean you have to remember when you're looking at period end, we did say 400 million off the sheet during the quarter Right?

[Brock Vandervliet, UBS]

Yes.

[Mac McCullough, CFO]

And -- but again, the thing that I've communicated time and time again about 2019 is the fact that we have a lot of flexibility in terms of how we manage our financials in 2019. The growth that we were expecting from the loan portfolio was not heroic on a period end to period end basis. And again, some of the liquidity that we have on the balance sheet gave us flexibility in terms of how we manage deposit pricing.

And then on the expense side, we had appropriate flexibility to be able to manage the positive operating leverage for 2019. So you will see continued loan growth. The pipelines are in good shape. We're going to be cautious as we move through 2019 and understand what's going to happen from an economy perspective, but you just need to take some of those factors into consideration when you take a look at the period end numbers.

[Brock Vandervliet, UBS]

Okay. Great. And just quickly on hedging. Earlier in the year, you had mentioned a goal of down 1% and a down 100 basis point ramp. You're 1.8% now. Obviously, the market has changed. Hedges are much more expensive. It sounds like you're not anticipating adding much more there based on the cost and based on your view of the forward curve. Is that accurate?

[Mac McCullough, CFO]

That would be correct. We will optimize our current position, but optimize is optimize. And I would tell you that we're in good shape in terms of how we're positioned right now with our hedges.

[Brock Vandervliet, UBS]

Great, thank you very much.

[Operator]

That concludes our question-and-answer session. I would like to turn the call back over to Mac for closing remarks.

[Mac McCullough, CFO]

Thank you, Sherri. I'm pleased with our solid results in the first half of the year, particularly given the significant amount of market volatility and the movement in the yield curve we have witnessed. I'm really confident about our prospects for the full year as we manage through what we expect to be a changing -- a challenging environment.

Our top priorities are executing our strategic plan to prudently grow revenue and to thoughtfully invest in our businesses for continued organic growth while also delivering annual positive operating leverage. We are building long-term shareholder value through a diligent focus on top quartile financial performance and consistently disciplined risk management.

And finally, as always, we'd like to end with a reminder to our shareholders that there's a high level of alignment between the Board, management, our colleagues and our shareholders. The Board and our colleagues are collectively a top 10 shareholder of Huntington, and all of us are appropriately focused on driving sustained long-term performance. Thank you for your interest in Huntington. We appreciate you joining the call today. Have a great day.

[Operator]

Thank you. This concludes today’s conference. You may disconnect your lines at this time and thank you for your participation.