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Huntington Bancshares Inc. (HBAN) reported earnings of 17 cents per share in the first quarter of 2013, beating the Zacks Consensus Estimate by a penny. However, results were stable compared with the prior-year quarter’s earnings.

Huntington’s results reflected growth in net interest income and reduced expenses. Improved credit quality trends were also a positive for the quarter. However, declining revenues due to a drop in the non-interest income was the headwind.

The company reported net income applicable to shareholders of $151.8 million in the reported quarter, down 1% from $153.3 in the year-ago quarter.

Performance in Detail

Huntington’s total revenue on a fully-taxable-equivalent (FTE) basis was $682.3 million, down 3% year over year. Moreover, the revenue figure was below the Zacks Consensus Estimate of $693 million.

Huntington’s net interest income (:NII) grew 2% from the prior-year quarter to $424.2 million on FTE basis in the reported quarter. Results reflect the impact of growth in average earning assets and rise in net interest margin (NIM).

NIM ascended 2 basis points year over year to 3.42% as a result of the decline in the cost of subordinated notes and other long-term debt along with reduced total deposit costs. This was partially mitigated by a shift in mix and impact from the change in yield of loans, total securities and on earnings assets.

Huntington’s non-interest income moved down 12% year over year to $252.2 million. The decline was due to lower gain on sale of loans related to the prior-year automobile loan securitization and a decline in other income related to the prior-year bargain purchase gain from the Fidelity Bank acquisition along with lower operating lease income.

However, non-interest expenses at Huntington declined 4% year over year to $442.8 million. The decline was mainly driven by lower other expense, decrease in deposit and other insurance costs, reflecting lower insurance premiums and professional services and a decrease in legal and outside consultant expenses. These positives were partially offset by a rise in personnel costs and increased outside data processing and other services, primarily associated with continued IT infrastructure investments.

Credit Quality

Credit quality metrics improved in the reported quarter. Huntington’s provision for credit losses decreased 14% from the prior-year quarter to $29.5 million. This reflected a decrease in net charge-offs (NCOs), which were $51.7 million or an annualized 0.51% of average total loans and leases in the reported quarter, down 38% from $83.0 million or an annualized 0.85% in the prior-year quarter.

Moreover, the quarter-end allowance for credit losses (:ACL), as a percentage of total loans and leases, decreased to 1.91% from 2.37% in the prior-year quarter.

Total non-performing assets (NPAs), including non-accrual loans and leases at Huntington were $415.5 million as of Mar 31, 2013 and represented 1.01% of related assets. This reflected a 21% decrease from $527.1 million or 1.29% of related assets at the end of the prior-year quarter.

Balance Sheet

Average loans and leases at Huntington increased 4% year over year to $40.9 billion. The rise reflected growth in average commercial and industrial (C&I) loans and average automobile loans partially mitigated by lower average commercial real estate (:CRE) loans.

Average total core deposits increased 6% year over year to $46.0 billion. This reflected growth in money market deposits and average non-interest bearing demand deposits, partially offset by decrease in average core certificates of deposit and other deposits.

Capital Ratios

Huntington’s capital ratios were mixed in the quarter. As of Mar 31, 2013, the tangible common equity to tangible assets ratio was 8.92%, up 59 basis points year over year. Tier 1 common risk-based capital ratio at quarter end was 10.47%, up 47 bps from the prior-year quarter.

However, the regulatory Tier 1 risk-based capital ratio as of Mar 31, 2013 was 12.16%, down from 12.22% as of Mar 31, 2012, mainly due to the redemption of $230 million in trust preferred securities during the year 2012 and repurchase of 28.1 million shares over the last four quarters.

Outlook

According to Huntington’s management, though improving trends in the Midwest region is being witnessed, customers are more concerned owing to the uncertainties in the broader economy.

During the course of 2013, average net interest income is projected to be modestly up. An increase in total loans excluding any impact of future loan securitizations is also expected. Such benefits are likely to be offset by the downward pressure on NIM.

During 2013, NIM is not expected to fall below the mid 3.30% range due to continued deposit repricing and mix shift opportunities while maintaining a disciplined approach to loan pricing.

Regarding loans, management expects its C&I portfolio to continue to exhibit growth in 2013. However, growth is expected to increase significantly in the second half of the year. Management anticipates one automobile loan securitization to occur in the second half of 2013.

Residential mortgages and home equity loan balances are anticipated to increase modestly while CRE loans would likely experience declines from the current levels, though these are expected to remain in the $5.0 billion range. Excluding any possible future automobile loan securitizations, an increase in total loans is likely to modestly surpass growth in total deposits, attributable to the company’s continued focus on the overall cost of funds, the continued shift towards low- and no-cost demand deposits and money market deposit accounts.

During 2013, non-interest income is projected to be relatively stable at current levels, after excluding the impact of any automobile loan sale or security gains and any net mortgage servicing right impact. The expected slowdown in mortgage banking activity is expected to be offset by continued growth in new customers, increased contribution from higher cross-sell, and the continued maturation of the company’s previous strategic investments.

Huntington’s expenses for the second quarter of 2013 are expected to escalate due to higher commission expense, annual merit increases, higher marketing expense and equipment related to continued in-store expansion. However, Huntington remains committed to posting positive operating leverage in 2013 as growth in total revenue is expected to outpace total expense growth.

Moreover, a continued improvement in the credit quality of Huntington is anticipated, with expectation of NCOs to remain volatile but expected to reach normalized levels by the end of 2013. However, with the level of provision for credit losses in the first quarter being at the lower end of management’s long-term expectation, given the uncertain and uneven nature of the economic recovery and the absolute low level of the provision for credit losses, the company expects some quarterly volatility.

Management anticipates an effective tax rate for the rest of 2013 to be in the range of 25% to 28%, primarily reflecting the impacts of tax-exempt income, tax advantaged investments, and general business credits.

Capital Deployment Update

Concurrent with the earnings release, Huntington’s board of directors declared a 25% increase in its quarterly cash dividend to 5 cents per share on its common stock. The dividend will be paid on Jul 1, 2013, to shareholders of record as of Jun 17.

In the reported quarter, Huntington repurchased 4.7 million shares at an average price of $7.07 per share. The board of directors also approved the repurchase of up to $227 million worth of common stock. This corresponds to a 25% increase from the recently completed common stock repurchase authorization. Both the aforementioned actions were proposed in Jan 2013 capital plan, which received approval from the Federal Reserve.

Our Viewpoint

Huntington has a solid franchise in the Midwest and is focused on capitalizing on its growth opportunities. The Fidelity Bank acquisition and the in-store banking deal augur well going forward. Capital deployment initiatives are encouraging.

Yet, revenue headwinds are a concern amidst a tepid economic recovery, low interest rate and a tough regulatory environment. Further, with an anticipation of a expanding expense base, we remain somewhat skeptical about its ability to augment earnings in the quarters ahead.