XNAS:HPCCP Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

QUARTERLY PERIOD ENDED March 31, 2012

 

Commission File Number 000-33243

 

Huntington Preferred Capital, Inc.

 

Ohio 31-1356967
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)

 

41 South High Street, Columbus, Ohio 43287

 

Registrant's telephone number (614) 480-8300

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.

x Yes ¨ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

x Yes ¨ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

  Large accelerated filer ¨ Accelerated filer ¨
  Non-accelerated filer   x (Do not check if a smaller reporting company) Smaller reporting company ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

¨Yes xNo

 

As of April 30, 2012, 14,000,000 shares of common stock without par value were outstanding, all of which were held by affiliates of the registrant.

 

 
 

 

HUNTINGTON PREFERRED CAPITAL, INC.
INDEX

 

PART 1. FINANCIAL INFORMATION  
       
  Item 1. Financial Statements (Unaudited)  
       
    Condensed Balance Sheets at March 31, 2012, December 31, 2011, and March 31, 2011 4
       
    Condensed Statements of Comprehensive Income for the three-months ended March 31, 2012 and 2011 5
       
    Condensed Statements of Changes in Shareholders' Equity for the three-months ended March 31, 2012 and 2011 6
       
    Condensed Statements of Cash Flows for the three months ended March 31, 2012 and 2011 7
       
    Notes to Unaudited Condensed Financial Statements 8
       
  Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 26
       
  Item 3. Quantitative and Qualitative Disclosures about Market Risk 35
       
  Item 4. Controls and Procedures 36
       
PART II. OTHER INFORMATION  
       
  Item 6. Exhibits 36
       
Signatures   37

 

2
 

 

Glossary of Acronyms and Terms

 

The following listing provides a comprehensive reference of common acronyms and terms used throughout the document:

 

ACL   Allowance for Credit Losses
Agreements   Third Amended and Restated Loan Participation Agreement, dated May 12, 2005, between the Bank and HPCI and the Third Amended and Restated Loan Subparticipation Agreement, dated May 12, 2005, between Holdings and HPCI
ALPL   Allowance for Loan Participation Losses
ASC   Accounting Standards Codification
ASU   Accounting Standards Update
AULPC   Allowance for Unfunded Loan Participation Commitments
Bank   The Huntington National Bank
C&I   Commercial and Industrial
CAP   Capital Assistance Program
CFPB   Bureau of Consumer Financial Protection
Codification   FASB Accounting Standards Codification
the Company   (see HPCI)
CRE   Commercial Real Estate
Dodd-Frank Act   Dodd-Frank Wall Street Reform and Consumer Protection Act
Exchange Act   Securities Exchange Act of 1934, as amended
Fannie Mae   (see FNMA)
FASB   Financial Accounting Standards Board
FFO   Funds from Operations
FHLB   Federal Home Loan Bank
FHLMC   Federal Home Loan Mortgage Corporation
FICO   Fair Isaac Corporation
Form 10-K   HPCI's Annual Report on Form 10-K for the year ended December 31, 2011
FNMA   Federal National Mortgage Association
Franklin   Franklin Credit Management Corporation
Freddie Mac   (see FHLMC)
GAAP   Generally Accepted Accounting Principles in the United States of America
Holdings   Huntington Preferred Capital Holdings, Inc.
HPCI   Huntington Preferred Capital, Inc.
HPCII   Huntington Preferred Capital II, Inc.
Huntington   Huntington Bancshares Incorporated
IRC   Internal Revenue Code
IRS   Internal Revenue Service
LGD   Loss Given Default
LIBOR   London Interbank Offered Rate
LTV   Loan to Value
MD&A   Management's Discussion and Analysis of Financial Condition and Results of Operations
NCO   Net Charge-off
NPAs   Nonperforming Assets
OCC   Office of the Comptroller of the Currency
OLEM   Other Loans Especially Mentioned
PD   Probability of Default
RBC   Risk-Based Capital
REIT   Real Estate Investment Trust
ROA   Return on Average Assets
ROE   Return on Average Equity
SAD   Special Assets Division
SEC   Securities and Exchange Commission
TARP   Troubled Asset Relief Program
TDR   Troubled Debt Restructuring
Treasury   U.S. Department of the Treasury

 

3
 

 

Part 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Huntington Preferred Capital, Inc.
Condensed Balance Sheets
(Unaudited)

 

   March 31,   December 31,   March 31, 
(dollar amounts in thousands, except share data)  2012   2011   2011 
Assets:               
Cash and interest-bearing deposits with The Huntington National Bank  $325,597   $228,958   $210,113 
Due from The Huntington National Bank   74,215    40,376    34,372 
Loan participation interests:               
Commercial real estate   3,084,553    3,149,330    2,974,096 
Consumer and residential real estate   404,801    434,272    528,605 
Total loan participation interests   3,489,354    3,583,602    3,502,701 
Allowance for loan participation losses   (70,722)   (83,772)   (95,866)
Net loan participation interests   3,418,632    3,499,830    3,406,835 
Accrued income and other assets   9,705    9,887    10,338 
Total assets  $3,828,149   $3,779,051   $3,661,658 
                
Liabilities and shareholders' equity               
Liabilities:               
Allowance for unfunded loan participation commitments  $845   $1,035   $1,583 
Dividends and distributions payable   2,594        383 
Other liabilities   57    78    67 
Total liabilities   3,496    1,113    2,033 
                
Shareholders' equity:               
Preferred securities, Class A, 8.000% noncumulative, non-               
exchangeable; $1,000 par and liquidation value per share;               
1,000 shares authorized, issued and outstanding   1,000    1,000    1,000 
Preferred securities, Class B, variable-rate noncumulative and               
conditionally exchangeable; $1,000 par and liquidation               
value per share; authorized 500,000 shares; 400,000               
shares issued and outstanding   400,000    400,000    400,000 
Preferred securities, Class C, 7.875% noncumulative and               
conditionally exchangeable; $25 par and liquidation               
value; 2,000,000 shares authorized, issued, and outstanding   50,000    50,000    50,000 
Preferred securities, Class E, variable-rate noncumulative and               
conditionally exchangeable; $250 par and liquidation               
value; 1,400,000 shares authorized, issued, and outstanding   350,000    350,000    350,000 
Preferred securities, $25 par, 10,000,000 shares               
authorized; no shares issued or outstanding            
Common stock - without par value; 14,000,000 shares authorized,               
issued and outstanding   2,810,116    2,810,116    2,810,116 
Retained earnings   213,537    166,822    48,509 
Total shareholders' equity   3,824,653    3,777,938    3,659,625 
Total liabilities and shareholders' equity  $3,828,149   $3,779,051   $3,661,658 

 

See notes to unaudited condensed financial statements.

 

4
 

 

Huntington Preferred Capital, Inc.
Condensed Statements of Comprehensive Income
(Unaudited)

 

   Three Months Ended 
   March 31, 
(dollar amounts in thousands)  2012   2011 
Interest and fee income          
Interest on loan participation interests:          
Commercial real estate  $28,583   $27,356 
Consumer and residential real estate   6,625    8,830 
Total loan participation interest income   35,208    36,186 
Fees from loan participation interests   245    369 
Interest on deposits with The Huntington National Bank   174    156 
Total interest and fee income   35,627    36,711 
           
Provision (reduction in allowance) for credit losses   (16,126)   (16,365)
           
Interest income after provision (reduction in allowance) for credit losses   51,753    53,076 
           
Noninterest income:          
Rental income   18    18 
Collateral fees   326    420 
Total noninterest income   344    438 
           
Noninterest expense:          
Servicing costs   1,645    1,787 
Other   159    164 
Total noninterest expense   1,804    1,951 
           
Net income  $50,293   $51,563 
           
Comprehensive income  $50,293   $51,563 
           
Dividends declared on preferred securities   3,578    3,054 
           
Net income applicable to common shares  $46,715   $48,509 

 

(1)All of HPCI’s common stock is owned by HPCII and Holdings and, therefore, net income per share is not presented.

 

See notes to unaudited condensed financial statements.

 

5
 

 

Huntington Preferred Capital, Inc.
Condensed Statements of Changes in Shareholders' Equity
(Unaudited)

 

   Preferred, Class A   Preferred, Class B   Preferred, Class C         
(all amounts in thousands)  Shares   Amount   Shares   Amount   Shares   Amount         
                                 
Three Months Ended March 31, 2011:                                        
                                         
Balance, beginning of period   1   $1,000    400   $400,000    2,000   $50,000          
                                         
Net income                                        
                                         
Dividends declared on Class A preferred securities                                        
Dividends declared on Class B preferred securities                                        
Dividends declared on Class C preferred securities                                        
Dividends declared on Class E preferred securities                                        
Balance, end of period   1   $1,000    400   $400,000    2,000   $50,000           
                                         
Three Months Ended March 31, 2012:                                        
Balance, beginning of period   1   $1,000    400   $400,000    2,000   $50,000           
                                         
Net income                                        
                                         
Dividends declared on Class A preferred securities                                        
Dividends declared on Class B preferred securities                                        
Dividends declared on Class C preferred securities                                        
Dividends declared on Class E preferred securities                                        
Balance, end of period   1   $1,000    400   $400,000    2,000   $50,000           

 

   Preferred, Class E   Preferred   Common   Retained     
(all amounts in thousands)  Shares   Amount   Shares   Amount   Shares   Amount   Earnings   Total 
                                         
Three Months Ended March 31, 2011:                                        
                                         
Balance, beginning of period   1,400   $350,000       $    14,000   $2,810,116   $   $3,611,116 
                                         
Net income                                 51,563    51,563 
                                         
Dividends declared on Class A preferred securities                                 (80)   (80)
Dividends declared on Class B preferred securities                                 (303)   (303)
Dividends declared on Class C preferred securities                                 (984)   (984)
Dividends declared on Class E preferred securities                                 (1,687)   (1,687)
Balance, end of period      $350,000       $    14,000   $2,810,116   $48,509   $3,659,625 
                                         
Three Months Ended March 31, 2012:                                        
                                         
Balance, beginning of period   1,400   $350,000       $    14,000   $2,810,116   $166,822   $3,777,938 
                                         
Net income                                 50,293    50,293 
                                         
Dividends declared on Class A preferred securities                                 (80)   (80)
Dividends declared on Class B preferred securities                                 (583)   (583)
Dividends declared on Class C preferred securities                                 (984)   (984)
Dividends declared on Class E preferred securities                                 (1,931)   (1,931)
Balance, end of period   1,400   $350,000       $    14,000   $2,810,116   $213,537   $3,824,653 

 

See notes to unaudited condensed financial statements.

6
 

 

Huntington Preferred Capital, Inc.
Condensed Statements of Cash Flows
(Unaudited)

 

   Three Months Ended 
   March 31, 
(dollar amounts in thousands)  2012   2011 
         
Operating activities          
Net income  $50,293   $51,563 
Adjustments to reconcile net income to net          
cash provided by operating activities:          
Provision (reduction in allowance) for credit losses   (16,126)   (16,365)
Change in due to/from The Huntington National Bank   (2,736)   823 
Other, net   1,308    (280)
Net cash provided by (used for) operating activities   32,739    35,741 
           
Investing activities          
Net participation interests acquired   (391,251)   (523,169)
Sales and repayments of loans underlying participation interests   456,135    561,992 
Net cash provided by (used for) investing activities   64,884    38,823 
           
Financing activities          
Dividends paid on preferred securities   (984)   (2,671)
Dividends paid on common stock       (149,899)
Return of capital to common shareholders       (350,101)
Net cash provided by (used for) financing activities   (984)   (502,671)
           
Increase (decrease) in cash and cash equivalents   96,639    (428,107)
Cash and cash equivalents at beginning of period   228,958    638,220 
Cash and cash equivalents at end of period  $325,597   $210,113 
           
Supplemental information:          
Dividends and distributions declared, not paid  $2,594   $383 
Non-cash change in loan participation activity with The Huntington National Bank   31,103    (26,621)

 

See notes to unaudited condensed financial statements.

 

7
 

 

Huntington Preferred Capital, Inc.

 

Notes to Unaudited Condensed Financial Statements

 

Note 1 - Organization

 

HPCI was organized under Ohio law in 1992, and designated as a REIT in 1998. HPCI’s principal business objective is to acquire, hold, and manage mortgage assets and other authorized investments that will generate net income for distribution to its shareholders. Two related parties own HPCI’s common stock: HPCII and Holdings.

 

HPCII and Holdings are direct and indirect subsidiaries of the Bank, a national banking association organized under the laws of the United States and headquartered in Columbus, Ohio. The Bank is a wholly owned subsidiary of Huntington. Huntington is a multi-state diversified financial holding company organized under Maryland law and headquartered in Columbus, Ohio. At March 31, 2012, the Bank, on a consolidated basis with its subsidiaries, accounted for over 99% of Huntington’s consolidated total assets and 92% of the year-to-date net income. Thus, for purposes of presenting consolidated financial statements for the Bank, Management considers information for the Bank and for Huntington to be substantially the same.

 

Note 2 - Basis of Presentation and New Accounting Pronouncements

 

The accompanying unaudited condensed financial statements of HPCI reflect all adjustments consisting of normal recurring accruals, which are, in the opinion of Management, necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented. These unaudited condensed financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission (SEC) and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted. The preparation of financial statements in conformity with GAAP requires Management to make estimates and assumptions that affect amounts reported in the financial statements. Actual results could differ from those estimates. Cash and cash equivalents used in the Condensed Statements of Cash Flows is defined as “Cash and interest-bearing deposits with The Huntington National Bank.” In conjunction with applicable accounting standards, all material subsequent events have been either recognized in the Unaudited Condensed Financial Statements or disclosed in the Notes to Unaudited Condensed Financial Statements.

 

The Notes to the Financial Statements appearing in HPCI’s Annual Report on Form 10-K for the year ended December 31, 2011 (Form 10-K), include descriptions of significant accounting policies, as updated by the information contained in this report, and should be read in conjunction with these interim financial statements. HPCI elected to be treated as a REIT for federal income tax purposes and intends to maintain compliance with the provisions of the Internal Revenue Code and, therefore, is not subject to federal income taxes. All of HPCI’s common stock is owned by affiliates; therefore, net income per common share information is not presented.

 

ASU 2011-04 — Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The ASU amends Topic 820 to add both additional clarifications to existing fair value measurement and disclosure requirements and changes to existing principles and disclosure guidance. Clarifications were made to the relevancy of the highest and best use valuation concept, measurement of an instrument classified in an entity’s shareholder’s equity and disclosure of quantitative information about the unobservable inputs for level 3 fair value measurements. Changes to existing principles and disclosures included measurement of financial instruments managed within a portfolio, the application of premiums and discounts in fair value measurement, and additional disclosures related to fair value measurements. The updated guidance and requirements are effective for financial statements issued for the first interim or annual period beginning after December 15, 2011, and should be applied prospectively. The amendments did not have a material impact on HPCI’s Unaudited Condensed Financial Statements.

 

ASU 2011-05 — Other Comprehensive Income (Topic 220), Presentation of Comprehensive Income. The ASU amends Topic 220 to require an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. An entity is also required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. The amendments do not change items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income, only the format for presentation. The updated guidance and requirements are effective for financial statements issued for the fiscal years, and the interim periods within those years, beginning after December 15, 2011. The amendments should be applied retrospectively. The amendment did not have a material impact on HPCI’s Unaudited Condensed Financial Statements.

 

8
 

 

ASU 2011-12 — Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. The ASU defers the effective date pertaining to reclassification adjustments out of accumulated other comprehensive income in ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, until the Board is able to redeliberate the matter. Management does not believe the amendment will have a material impact on HPCI’s Unaudited Condensed Financial Statements.

 

Note 3 – Loan Participation Interests and Allowance for Credit Losses

 

Loan participation interests are categorized based on the collateral underlying the loan. At March 31, 2012, December 31, 2011, and March 31, 2011, loan participation interests were comprised of the following:

 

   March 31,   December 31,   March 31, 
(dollar amounts in thousands)  2012   2011   2011 
             
Commercial real estate  $3,084,553   $3,149,330   $2,974,096 
Consumer and residential real estate   404,801    434,272    528,605 
Total loan participation interests  $3,489,354   $3,583,602   $3,502,701 

 

As shown in the table above, the Company’s primary loan participation interest portfolios are: CRE and consumer and residential real estate. Classes are generally disaggregations of a portfolio. The classes within the CRE portfolio are: retail properties, multi family, office, industrial and warehouse, and other CRE. The classes within the consumer and residential real estate portfolio are: first-lien loan participation interests and second-lien loan participation interests.

 

As defined by regulatory guidance, there were no underlying loans outstanding that would be considered a concentration of lending in any particular industry, group of industries, or business activity. Underlying loans were, however, generally collateralized by real estate. Loans made to borrowers in the five states of Ohio, Michigan, Indiana, Pennsylvania, and Kentucky comprised approximately 94%, 93%, and 95% of the portfolio at March 31, 2012, December 31, 2011, and March 31, 2011, respectively.

 

Loan Participation Interest Purchases and Sales

 

The following table summarizes significant portfolio purchase activity during the three-month periods ended March 31, 2012 and 2011:

 

       Consumer and     
   Commercial   Residential     
(dollar amounts in thousands)  Real Estate   Real Estate   Total 
Portfolio loan participation interests purchased during the:               
                
Three-month period ended March 31, 2012  $431,890   $   $431,890 
Three-month period ended March 31, 2011   427,326        427,326 

 

There were no significant portfolio loan participation interest sales during either of the three-month periods ended March 31, 2012 and 2011.

 

NPAs and Past Due Loan Participation Interests

 

Loan participation interests are considered past due when the contractual amounts due with respect to principal and interest are not received within 30 days of the contractual due date.

 

Any loan participation interest in any portfolio may be placed on nonaccrual status prior to the policies described below when collection of principal or interest is in doubt.

 

Loan participation interests in all classes within the CRE portfolio are placed on nonaccrual status at 90-days past due. First-lien consumer and residential real estate loan participation interests are placed on nonaccrual status at 150-days past due. Second-lien consumer and residential real estate loan participation interests are placed on nonaccrual status at the earlier of 120-days past due or when the related first-lien loan has been identified as nonaccrual. For all classes within all portfolios, when a loan participation interest is placed on nonaccrual status, any accrued interest income is reversed with current year accruals charged to interest income, and prior year amounts charged-off as a credit loss.

 

9
 

 

We have identified an emerging trend where borrowers are making a purposeful financial decision to stop making required payments on the second-lien, and in some cases, the first-lien. This strategic default scenario is generally associated with borrowers that have very limited or no history of delinquency. These accounts also tend to migrate quickly from a current status to charge-off without the historical stops at each delinquency stage. The resulting increase in the relative speed of the migration from current status to charge-off represents a negative impact to the longer term performance of the portfolio.  Effective with the 2012 first quarter, any second-lien loan participation interest associated with a nonaccruing first-lien loan participation interest is also placed on nonaccrual status. This policy change did not have a material impact on HPCI’s Unaudited Condensed Financial Statements.

 

For all classes within all portfolios, cash receipts received on NPAs are applied entirely against principal until the loan has been collected in full, after which time any additional cash receipts are recognized as interest income.

 

Regarding all classes within all portfolios, when, in Management’s judgment, the borrower’s ability to make required principal and interest payments resumes and collectability is no longer in doubt, the loan participation interest is returned to accrual status. For these loan participation interests that have been returned to accrual status, cash receipts are applied according to the contractual terms of the loan.

 

The following table presents NPAs by loan class at March 31, 2012, December 31, 2011, and March 31, 2011:

 

   2012   2011 
(dollar amounts in thousands)  March 31,   December 31,   March 31, 
             
Commercial real estate:               
Industrial and warehouse  $2,105   $15,346   $5,735 
Retail properties   11,122    8,107    9,184 
Office   7,789    8,476    2,565 
Multi family   1,224    1,248    2,292 
Other commercial real estate   9,474    12,308    21,073 
Total commercial real estate  $31,714   $45,485   $40,849 
                
Consumer and residential real estate:               
Secured by first-lien  $5,135   $5,387   $3,631 
Secured by second-lien   546    710    775 
Total consumer and residential real estate  $5,681   $6,097   $4,406 
Total nonperforming assets  $37,395   $51,582   $45,255 

 

The following table presents an aging analysis of loan participation interests, including past due loan participation interests, by loan class at March 31, 2012, December 31, 2011, and March 31, 2011: (1)

 

   March 31, 2012 
   Past Due       Total Loan   90 or More 
           90 or           Participation   Days Past Due 
(dollar amounts in thousands)  30-59 days   60-89 days   more days   Total   Current   Interests   and Accruing 
                             
Commercial real estate:                                   
Industrial and warehouse  $   $   $2,092   $2,092   $729,627   $731,719   $ 
Retail properties   4,248    4,730    5,718    14,696    638,000    652,696     
Office   175        7,060    7,235    514,082    521,317     
Multi family   137    12    1,212    1,361    222,020    223,381     
Other commercial real estate   1,918    508    8,231    10,657    944,783    955,440     
Total commercial real estate  $6,478   $5,250   $24,313   $36,041   $3,048,512   $3,084,553   $ 
                                    
Consumer and residential real estate:                                   
Secured by first-lien  $8,577   $1,336   $6,874   $16,787   $281,786   $298,573   $1,739 
Secured by second-lien   2,710    854    1,125    4,689    101,539    106,228    579 
Total consumer and residential real estate  $11,287   $2,190   $7,999   $21,476   $383,325   $404,801   $2,318 

 

10
 

 

   December 31, 2011 
   Past Due       Total Loan   90 or More 
           90 or           Participation   Days Past Due 
(dollar amounts in thousands)  30-59 days   60-89 days   more days   Total   Current   Interests   and Accruing 
                             
Commercial real estate:                                   
Industrial and warehouse  $395   $10   $14,952   $15,357   $727,251   $742,608   $ 
Retail properties   782    613    6,067    7,462    662,450    669,912     
Office   296    196    7,922    8,414    515,784    524,198     
Multi family       13    1,236    1,249    216,803    218,052     
Other commercial real estate   847    596    11,304    12,747    981,813    994,560     
Total commercial real estate  $2,320   $1,428   $41,481   $45,229   $3,104,101   $3,149,330   $ 
                                    
Consumer and residential real estate:                                   
Secured by first-lien  $5,590   $2,143   $9,112   $16,845   $303,750   $320,595   $3,725 
Secured by second-lien   2,831    1,212    1,192    5,235    108,442    113,677    483 
Total consumer and residential real estate  $8,421   $3,355   $10,304   $22,080   $412,192   $434,272   $4,208 

 

   March 31, 2011 
   Past Due       Total Loan   90 or More 
           90 or           Participation   Days Past Due 
(dollar amounts in thousands)  30-59 days   60-89 days   more days   Total   Current   Interests   and Accruing 
                             
Commercial real estate:                                   
Industrial and warehouse  $1,029   $208   $4,004   $5,241   $671,241   $676,482   $ 
Retail properties   353    1,910    7,755    10,018    583,184    593,202     
Office   12,673    447    2,272    15,392    519,190    534,582     
Multi family   741    1,288    1,004    3,033    228,669    231,702     
Other commercial real estate   3,009    1,099    19,156    23,264    914,864    938,128     
Total commercial real estate  $17,805   $4,952   $34,191   $56,948   $2,917,148   $2,974,096   $ 
                                    
Consumer and residential real estate:                                   
Secured by first-lien  $8,884   $2,375   $5,969   $17,228   $359,951   $377,179   $2,338 
Secured by second-lien   3,551    747    1,653    5,951    145,475    151,426    878 
Total consumer and residential real estate  $12,435   $3,122   $7,622   $23,179   $505,426   $528,605   $3,216 

 

(1)  NPAs are included in this aging analysis based on the loan participation interest's past due status.

 

Allowance for Credit Losses

 

The ACL is comprised of the ALPL and the AULPC, and reflects Management’s judgment regarding the appropriate level necessary to absorb credit losses inherent in the loan participation interest portfolio. It is HPCI’s policy to utilize the Bank’s analysis as of the end of each reporting date to estimate the required level of the ALPL and AULPC. The determination of the ACL requires significant estimates, including the timing and amounts of expected future cash flows on impaired loan participation interests, consideration of economic conditions, and historical loss experience pertaining to pools of homogeneous loan participation interests, all of which may be susceptible to change.

 

The appropriateness of the ACL is based on Management’s current judgments about the credit quality of the loan participation interests portfolio. These judgments consider on-going evaluations of the loan participation interests portfolio, including such factors as the differing economic risks associated with each loan participation interests category, the financial condition of specific borrowers, the level of delinquent loan participation interests, the value of any collateral and, where applicable, the existence of any guarantees or other documented support. Further, Management evaluates the impact of changes in interest rates and overall economic conditions on the ability of borrowers to meet their financial obligations when quantifying the exposure to credit losses and assessing the appropriateness of the ACL at each reporting date. In addition to general economic conditions and the other factors described above, additional factors also considered include: the impact of declining residential real estate values; the diversification of commercial real estate loan participation interests; and the amount of loan participation interests to businesses in areas of Ohio and Michigan that have historically experienced less economic growth compared with Pennsylvania, Indiana, and Kentucky. Also, the ACL assessment includes the on-going assessment of credit quality metrics, and a comparison of certain ACL benchmarks to current performance.

 

11
 

 

ALPL is transferred to HPCI directly from the Bank on loan participation interests underlying the participation interests at the time the participation interests are acquired. This transfer of ALPL is reflected as ALPL acquired, rather than HPCI recording provision for credit losses. Based on Management’s quarterly evaluation of the factors previously mentioned, the ALPL may either be increased through a provision for credit losses, net of recoveries, and charged to earnings or lowered through a reduction in allowance for credit losses, net of recoveries, and credited to earnings. Credit losses are charged against the ALPL when Management believes the loan participation interest balance, or a portion thereof, is uncollectible.

 

The ALPL consists of two components: (1) the transaction reserve, which includes specific reserves related to loan participation interests considered to be impaired and loan participation interests involved in TDRs, and (2) the general reserve. The transaction reserve component includes both (1) an estimate of loss based on pools of commercial and consumer loan participation interests with similar characteristics and (2) an estimate of loss based on an impairment review of each CRE loan participation interest greater than $1.0 million. For the CRE portfolio, the estimate of loss based on pools of loan participation interests with similar characteristics is made by applying a PD factor and a LGD factor to each individual loan based on a continuously updated loan grade, using a standardized loan grading system. The PD and LGD factors are determined for each loan grade using statistical models based on historical performance data. The PD factor considers on-going reviews of the financial performance of the specific borrower, including cash flow, debt-service coverage ratio, earnings power, debt level, and equity position, in conjunction with an assessment of the borrower’s industry and future prospects. The LGD factor considers analysis of the type of collateral and the relative LTV ratio. These reserve factors are developed based on credit migration models that track historical movements of loan participation interests between loan ratings over time and a combination of long-term average loss experience of our own portfolio and external industry data using a 24-month emergence period.

 

In the case of more homogeneous portfolios, such as the consumer and residential real estate portfolio, the determination of the transaction reserve also incorporates PD and LGD factors, however, the estimate of loss is based on pools of loan participation interests with similar characteristics. The PD factor considers current credit scores unless the account is delinquent, in which case a higher PD factor is used. The credit score provides a basis of understanding the borrowers past and current payment performance, and this information is used to estimate expected losses over the subsequent 12-month period. The performance of first-lien loans ahead of second-lien loans is available to use as part of the updated score process. The LGD factor considers analysis of the type of collateral and the relative LTV ratio. Credit scores, models, analyses, and other factors used to determine both the PD and LGD factors are updated frequently to capture the recent behavioral characteristics of the subject portfolios, as well as any changes in loss mitigation or credit origination strategies, and adjustments to the allowance factors are made as needed.

 

The general reserve consists of economic reserve and risk-profile reserve components. The economic reserve component considers the potential impact of changing market and economic conditions on portfolio performance. The risk-profile component considers items unique to our structure, policies, processes, and portfolio composition, as well as qualitative measurements and assessments of the portfolios including, but not limited to, management quality, concentrations, portfolio composition, industry comparisons, and internal review functions.

 

The estimate for the AULPC is determined using the same procedures and methodologies as used for the ALPL. The loss factors used in the AULPC are the same as the loss factors used in the ALPL while also considering a historical utilization of unused commitments.

 

The following table presents ALPL and AULPC activity by portfolio segment for the three-month periods ended March 31, 2012 and 2011:

 

   Commercial   Consumer and     
   Real Estate   Residential Real Estate   Total 
             
(dollar amounts in thousands)            
             
Three-month period ended March 31, 2012:               
ALPL balance, beginning of period  $71,555   $12,217   $83,772 
Allowance related to loan participations acquired   4,942        4,942 
Loan participation charge-offs   (3,587)   (2,169)   (5,756)
Recoveries of loan participations previously charged-off   3,439    261    3,700 
Provision (reduction in allowance) for loan participation interest losses   (16,706)   770    (15,936)
ALPL balance, end of period  $59,643   $11,079   $70,722 
                
AULPC balance, beginning of period  $1,035   $   $1,035 
Provision (reduction in allowance) for unfunded loan participation commitment losses   (190)       (190)
AULPC balance, end of period  $845   $   $845 
                
ACL balance, end of period  $60,488   $11,079   $71,567 

 

12
 

 

   Commercial   Consumer and     
   Real Estate   Residential Real Estate   Total 
             
(dollar amounts in thousands)            
             
Three-month period ended March 31, 2011:               
ALPL balance, beginning of period  $97,920   $12,183   $110,103 
Allowance related to loan participations acquired   8,519        8,519 
Loan participation charge-offs   (5,608)   (2,609)   (8,217)
Recoveries of loan participations previously charged-off   1,568    243    1,811 
Provision (reduction in allowance) for loan participation interest losses   (19,610)   3,260    (16,350)
ALPL balance, end of period  $82,789   $13,077   $95,866 
                
AULPC balance, beginning of period  $1,598   $   $1,598 
Provision (reduction in allowance) for unfunded loan participation commitment losses   (15)       (15
AULPC balance, end of period  $1,583   $   $1,583 
                
ACL balance, end of period  $84,372   $13,077   $97,449 

 

Any loan participation interest in any portfolio may be charged-off prior to the policies described below if a loss confirming event has occurred. Loss confirming events include, but are not limited to, bankruptcy (unsecured), continued delinquency, foreclosure, or receipt of an asset valuation indicating a collateral deficiency and that asset is the sole source of repayment.

 

CRE loan participation interests are either charged-off or written down to net realizable value at 90-days past due. First-lien and second-lien consumer and residential real estate loan participation interests are charged-off to the estimated fair value of the collateral at 150-days past due and 120-days past due, respectively.

 

Credit Quality Indicators

 

To facilitate the monitoring of credit quality for CRE loan participation interests, and for purposes of determining an appropriate ACL level for these loan participation interests, the following categories of credit grades are utilized:

 

Pass = Higher quality loan participation interests that do not fit any of the other categories described below.

 

OLEM = Potentially weak loan participation interests. The credit risk may be relatively minor yet represent a risk given certain specific circumstances. If the potential weaknesses are not monitored or mitigated, the asset may weaken or inadequately protect the Company’s position in the future.

 

Substandard = Inadequately protected loan participation interests by the borrower’s ability to repay, equity, and/or the collateral pledged to secure the loan participation interest. These loan participation interests have identified weaknesses that could hinder normal repayment or collection of the debt. It is likely that the Company will sustain some loss if any identified weaknesses are not mitigated.

 

Doubtful = Loan participation interests that have all of the weaknesses inherent in those loan participation interests classified as Substandard, with the added elements of the full collection of the loan participation interest is improbable and that the possibility of loss is high.

 

The categories above, which are derived from standard regulatory rating definitions, are assigned upon initial approval of the loan participation interest and subsequently updated as appropriate.

 

13
 

 

Commercial loan participation interests categorized as OLEM, Substandard, or Doubtful are considered Criticized loan participation interests. Commercial loan participation interests categorized as Substandard or Doubtful are considered Classified loan participation interests.

 

For all classes within the consumer and residential real estate portfolio, each loan participation interest is assigned a specific PD factor that is generally based on the borrower’s most recent credit bureau score (FICO), which is updated quarterly. A FICO credit bureau score is a credit score developed by Fair Isaac Corporation based on data provided by the credit bureaus. The FICO credit bureau score is widely accepted as the standard measure of consumer credit risk used by lenders, regulators, rating agencies, and consumers. The higher the FICO credit bureau score, the better the odds of repayment and therefore, an indicator of lower credit risk.

 

14
 

 

The following table presents loan participation interest balances by credit quality indicator as of March 31, 2012, December 31, 2011, and March 31, 2011:

 

   March 31, 2012 
   Credit Risk Profile by UCS classification 
(dollar amounts in thousands)  Pass   OLEM   Substandard   Doubtful   Total 
Commercial real estate:                         
Industrial and warehouse  $704,829   $11,291   $15,599   $   $731,719 
Retail properties   597,839    35,538    19,319        652,696 
Office   493,442    7,538    20,252    85    521,317 
Multi family   211,366    1,209    10,806        223,381 
Other commercial real estate   895,990    33,763    25,687        955,440 
Total commercial real estate  $2,903,466   $89,339   $91,663   $85   $3,084,553 

 

   Credit Risk Profile by FICO score (1) 
   750+   650-749   <650   Other   Total 
Consumer and residential real estate:                         
Secured by first-lien  $127,807   $105,898   $64,868   $   $298,573 
Secured by second-lien   36,298    38,566    31,364        106,228 
Total consumer and residential real estate  $164,105   $144,464   $96,232   $   $404,801 

 

   December 31, 2011 
   Credit Risk Profile by UCS classification 
(dollar amounts in thousands)  Pass   OLEM   Substandard   Doubtful   Total 
Commercial real estate:                         
Industrial and warehouse  $703,043   $11,698   $27,867   $   $742,608 
Retail properties   606,479    46,779    16,654        669,912 
Office   494,932    15,041    14,140    85    524,198 
Multi family   204,221    2,943    10,888        218,052 
Other commercial real estate   927,974    38,368    28,218        994,560 
Total commercial real estate  $2,936,649   $114,829   $97,767   $85   $3,149,330 

 

   Credit Risk Profile by FICO score (1) 
   750+   650-749   <650   Other   Total 
Consumer and residential real estate:                         
Secured by first-lien  $142,627   $111,308   $66,660   $   $320,595 
Secured by second-lien   38,997    42,069    32,611        113,677 
Total consumer and residential real estate  $181,624   $153,377   $99,271   $   $434,272 

 

   March 31, 2011 
   Credit Risk Profile by UCS classification 
(dollar amounts in thousands)  Pass   OLEM   Substandard   Doubtful   Total 
Commercial real estate:                         
Industrial and warehouse  $614,192   $23,548   $38,708   $34   $676,482 
Retail properties   561,577    16,135    15,490    -    593,202 
Office   492,784    21,312    20,401    85    534,582 
Multi family   215,067    3,096    13,539    -    231,702 
Other commercial real estate   873,841    12,035    52,252    -    938,128 
Total commercial real estate  $2,757,461   $76,126   $140,390   $119   $2,974,096 

 

   Credit Risk Profile by FICO score (1) 
   750+   650-749   <650   Other   Total 
Consumer and residential real estate:                         
Secured by first-lien  $175,746   $131,800   $69,632   $   $377,178 
Secured by second-lien   55,759    54,937    40,731        151,427 
Total consumer and residential real estate  $231,505   $186,737   $110,363   $   $528,605 

 

(1)  Reflects currently updated customer credit scores.

 

15
 

 

Impaired Loans

 

For all classes within the CRE portfolio, all loan participation interests with an outstanding balance of greater than $1.0 million are considered for individual impairment evaluation on a quarterly basis. Generally, consumer loan participation interests within any class are not individually evaluated on a regular basis for impairment. Additionally, all TDRs, regardless of the outstanding balance amount, are also considered impaired.

 

Once a loan participation interest has been identified for an assessment of impairment, the loan participation interest is considered impaired when, based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. This determination requires significant judgment and use of estimates, and the eventual outcome may differ significantly from those estimates.

 

When a loan participation interest in any class has been determined to be impaired, the amount of the impairment is measured using the present value of expected future cash flows discounted at the loan participation interest’s effective interest rate or, as a practical expedient, the observable market price of the loan participation interest, or the fair value of the collateral if the loan participation interest is collateral-dependent. When the present value of expected future cash flows is used, the effective interest rate is the original contractual interest rate of the loan participation interest adjusted for any premium or discount. When the contractual interest rate is variable, the effective interest rate of the loan participation interest changes over time. A specific reserve is established as a component of the ALPL when a loan participation interest has been determined to be impaired. Subsequent to the initial measurement of impairment, if there is a significant change to the impaired loan participation interest's expected future cash flows, or if actual cash flows are significantly different from the cash flows previously estimated, the impairment is recalculated and the specific reserve is appropriately adjusted. Similarly, if impairment is measured based on the observable market price of an impaired loan participation interest or the fair value of the collateral of an impaired collateral-dependent loan participation interest, the specific reserve is adjusted.

 

When a loan participation interest within any class is impaired, interest income is discontinued unless the receipt of principal and interest is no longer in doubt. Interest income on TDRs is accrued when all principal and interest is expected to be collected under the post-modification terms. Cash receipts received on nonaccrual impaired loan participation interests within any class are generally applied entirely against principal until the loan participation interest has been collected in full, after which time any additional cash receipts are recognized as interest income. Cash receipts received on accruing impaired loan participation interests within any class are applied in the same manner as accruing loan participation interests that are not considered impaired.

 

16
 

 

The following tables present the balance of the ALPL attributable to loans by portfolio segment individually and collectively evaluated for impairment and the related loan participation interest balance at March 31, 2012, December 31, 2011, and March 31, 2011: (1)

 

       Consumer and     
   Commercial   Residential     
   Real Estate   Real Estate   Total 
             
ALPL at March 31, 2012:               
(dollar amounts in thousands)               
                
Portion of ending balance:               
                
Attributable to loan participation interests individually evaluated for impairment  $1,656   $402   $2,058 
Attributable to loan participation interests collectively evaluated for impairment   57,987    10,677    68,664 
Total ALPL balance  $59,643   $11,079   $70,722 
                
Loan Participation Interests at March 31, 2012:               
                
Portion of ending balance:               
                
Individually evaluated for impairment  $15,949   $19,530   $35,479 
Collectively evaluated for impairment   3,068,604    385,271    3,453,875 
Total loan participation interests evaluated for impairment  $3,084,553   $404,801   $3,489,354 
                
ALPL at December 31, 2011:               
                
Portion of ALPL balance:               
                
Attributable to loan participation interests individually evaluated for impairment  $3,274   $531   $3,805 
Attributable to loan participation interests collectively evaluated for impairment   68,281    11,686    79,967 
Total ALPL balance  $71,555   $12,217   $83,772 
                
Loan Participation Interests at December 31, 2011:               
                
Portion of ending balance:               
                
Individually evaluated for impairment  $24,597   $14,599   $39,196 
Collectively evaluated for impairment   3,124,733    419,673    3,544,406 
Total loan participation interests evaluated for impairment  $3,149,330   $434,272   $3,583,602 
                
ALPL at March 31, 2011:               
                
Portion of ALPL balance:               
                
Attributable to loan participation interests individually evaluated for impairment  $2,364   $609   $2,973 
Attributable to loan participation interests collectively evaluated for impairment   80,425    12,468    92,893 
Total ALPL balance  $82,789   $13,077   $95,866 
                
Loan Participation Interests at March 31, 2011:               
                
Portion of ending balance:               
                
Individually evaluated for impairment  $13,780   $14,929   $28,709 
Collectively evaluated for impairment   2,960,316    513,676    3,473,992 
Total loan participation interests evaluated for impairment  $2,974,096   $528,605   $3,502,701 

 

(1)  No loans with deteriorated credit quality, as defined by ASC 310-30, have been acquired.

 

17
 

 

The following tables present, by class, the ending, unpaid principal balance, and the related ALPL, along with the average balance and interest income recognized only for loan participation interests individually evaluated for impairment at March 31, 2012, December 31, 2012, and March 31, 2011: (1), (2)

 

(dollar amounts in thousands)              Three Months Ended 
   March 31, 2012   March 31, 2012 
       Unpaid           Interest 
   Ending   Principal   Related   Average   Income 
   Balance   Balance (4)   Allowance   Balance   Recognized 
                     
With no related allowance recorded:                         
Commercial real estate:                         
Industrial and warehouse  $   $   $   $   $ 
Retail properties                    
Office                    
Multi family                    
Other commercial real estate                    
Total commercial real estate  $   $   $   $   $ 
                          
With an allowance recorded:                         
Commercial real estate: (3)                         
Industrial and warehouse  $2,082   $2,082   $75   $6,942   $15 
Retail properties   6,638    8,296    415    3,529     
Office   4,984    11,822    529    5,022     
Multi family   1,091    1,295    57    1,716    4 
Other commercial real estate   1,154    2,342    580    1,155    1 
Total commercial real estate  $15,949   $25,837   $1,656   $18,364   $20 
                          
Consumer and residential real estate:                         
Secured by first-lien  $16,944   $17,495   $239   $14,423   $178 
Secured by second-lien   2,586    2,586    163    2,642    43 
Total consumer and residential real estate  $19,530   $20,081   $402   $17,065   $221 
18
 

 

(dollar amounts in thousands)            
   December 31, 2011 
   Ending   Unpaid Principal   Related 
   Balance   Balance (4)   Allowance 
             
With no related allowance recorded:               
Commercial real estate:               
Industrial and warehouse  $   $   $ 
Retail properties            
Office            
Multi family            
Other commercial real estate            
Total commercial real estate  $   $   $ 
                
With an allowance recorded:               
Commercial real estate:               
Industrial and warehouse  $14,544   $22,484   $1,370 
Retail properties   1,755    3,278    488 
Office   5,100    11,822    645 
Multi family   2,042    2,225    189 
Other commercial real estate   1,156    2,345    582 
Total commercial real estate  $24,597   $42,154   $3,274 
                
Consumer and residential real estate:               
Secured by first-lien  $11,901   $12,424   $309 
Secured by second-lien   2,698    2,698    222 
Total consumer and residential real estate  $14,599   $15,122   $531 

 

(dollar amounts in thousands)              Three Months Ended 
   March 31, 2011   March 31, 2011 
       Unpaid           Interest 
   Ending   Principal   Related   Average   Income 
   Balance   Balance (4)   Allowance   Balance   Recognized 
                     
With no related allowance recorded:                         
Commercial real estate:                         
Industrial and warehouse  $   $   $   $   $ 
Retail properties   3,155    5,908        5,064     
Office                    
Multi family                    
Other commercial real estate               82     
Total commercial real estate  $3,155   $5,908   $   $5,146   $ 
                          
With an allowance recorded:                         
Commercial real estate:                         
Industrial and warehouse  $   $   $   $   $ 
Retail properties               2,317     
Office                    
Multi family   2,288    2,724    473    1,676     
Other commercial real estate   8,337    11,792    1,891    12,309    5 
Total commercial real estate  $10,625   $14,516   $2,364   $16,302   $5 
                          
Consumer and residential real estate:                         
Secured by first-lien  $11,499   $12,031   $288   $7,481   $117 
Secured by second-lien   3,430    3,430    321    3,430    55 
Total consumer and residential real estate  $14,929   $15,461   $609   $10,911   $172 

 

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(1)These tables do not include loan participation interests which are fully charged-off.
(2)All consumer and residential real estate impaired loan participation interests are considered impaired due to their status as a TDR.
(3)At March 31, 2012, $956 thousand of the $15,949 thousand of commercial real estate loan participation interests with an allowance recorded were considered impaired due to their status as a TDR.
(4)The differences between the ending balance and unpaid principal balance amounts represent partial charge-offs.

 

TDR Loan Participation Interests

 

TDRs are modified loan participation interests where a concession was provided to a borrower experiencing financial difficulties. Loan participation interest modifications are considered TDRs when the concessions provided are not available to the borrower through either the Bank’s normal channels or other sources. However, not all loan participation interest modifications are TDRs.

 

TDR Concession Types

 

The Bank’s standards relating to loan modifications consider, among other factors, minimum verified income requirements, cash flow analysis, and collateral valuations. Each potential loan modification is reviewed individually and the terms of the loan are modified to meet a borrower’s specific circumstances at a point in time. All loan modifications, including those classified as TDRs, are reviewed and approved by the Bank’s Special Assets Division. The types of concessions provided to borrowers include:

 

·Interest rate reduction: A reduction of the stated interest rate to a nonmarket rate for the remaining original life of the debt.

 

·Amortization or maturity date change beyond what the collateral supports, including any of the following:

 

(1)Lengthens the amortization period of the amortized principal beyond market terms. This concession reduces the minimum monthly payment and increases the amount of the balloon payment at the end of the term of the loan. Principal is generally not forgiven.
(2)Reduces the amount of loan principal to be amortized. This concession also reduces the minimum monthly payment and increases the amount of the balloon payment at the end of the term of the loan. Principal is generally not forgiven.
(3)Extends the maturity date or dates of the debt beyond what the collateral supports. This concession generally applies to loans without a balloon payment at the end of the term of the loan.

 

·Other: A concession that is not categorized as one of the concessions described above. These concessions include, but are not limited to: principal forgiveness, collateral concessions, covenant concessions, and reduction of accrued interest. Principal forgiveness may result from any TDR modification of any concession type. However, the aggregate amount of principal forgiven as a result of loans modified as TDRs during the three-month period ended March 31, 2012, was not significant.

 

TDRs by Loan Participation Interest Type

 

The following is a description of TDRs by loan participation interest type:

 

Commercial real estate loan participation interest TDRs – CRE accruing TDRs often result from loan participation interests receiving a concession with terms that are not considered a market transaction to the Bank. The TDR remains in accruing status as long as the customer is less than 90-days past due on payments per the restructured loan participation interest terms and no loss is expected.

 

CRE nonaccrual TDRs result from either: (1) an accruing CRE TDR being placed on nonaccrual status, or (2) a workout where an existing CRE NAL is restructured and a concession was given. At times, these workouts restructure the NAL so that two or more new notes are created. The primary note is underwritten based upon the Bank’s normal underwriting standards and is sized so projected cash flows are sufficient to repay contractual principal and interest. The terms on the secondary note(s) vary by situation, and may include notes that defer principal and interest payments until after the primary note is repaid. Creating two or more notes often allows the borrower to continue a project or weather a temporary economic downturn and allows the Bank to right-size a loan based upon the current expectations for a project’s performance.

 

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Our strategy involving TDR borrowers includes working with these borrowers to allow them to refinance elsewhere as well as allow them time to improve their financial position and remain our customer through refinancing their notes according to market terms and conditions in the future. A refinancing or modification of a loan occurs when either the loan matures according to the terms of the TDR-modified agreement or the borrower requests a change to the loan agreements. At that time, the loan is evaluated to determine if it is creditworthy. It is subjected to the Bank’s normal underwriting standards and process for similar credit extensions, both new and existing.

 

In accordance with ASC 310-20-35, the refinanced note is evaluated to determine if it is considered a new loan or a continuation of the prior loan. A new loan is considered for removal of the TDR designation, whereas a continuation of the prior note requires a continuation of the TDR designation. In order for the TDR designation to be removed, the borrower must no longer be experiencing financial difficulties and the terms of the refinanced loan must not represent a concession.

 

Consumer and residential real estate loan participation interest TDRs – Consumer and residential real estate TDRs represent loan modifications associated with traditional first-lien mortgage loans, as well as first-lien and second-lien home equity loans, in which a concession has been provided to the borrower. The primary concessions given to these borrowers are amortization or maturity date changes and interest rate reductions. Consumer and residential real estate loans identified as TDRs include borrowers unable to refinance their mortgages through the Bank’s normal mortgage origination channels or through other independent sources. Some, but not all, of the loans may be delinquent.

 

TDR Impact on Credit Quality

 

The ALPL is largely driven by updated risk ratings assigned to CRE loan participation interests, updated borrower credit scores on consumer and residential real estate, and borrower delinquency history in both portfolios. As such, the provision for credit losses is impacted primarily by changes in borrower payment performance rather than the TDR classification. TDRs can be classified as either accrual or nonaccrual loan participation interests. Nonaccrual TDRs are included in NPAs whereas accruing TDRs are excluded from NPAs as it is probable that all contractual principal and interest due under the restructured terms will be collected.

 

TDR concessions and classification may reduce the ALPL within certain classes, specifically the CRE portfolio. The reduction is derived from the type of concessions given to the borrowers and the resulting application of the transaction reserve calculation within the ALPL.  The transaction reserve for non-TDR loans is calculated based upon several estimated probability factors, such as PD and LGD, both of which were previously discussed above.  Upon the occurrence of a TDR, the transaction reserve is measured based on the estimation of the probable discounted future cash flows expected to be collected on the modified loan.  The resulting TDR ALPL calculation often results in a minimal or zero ALPL amount because (1) it is probable all cash flows will be collected and, (2) due to the rate increase, the discounting of the cash flows on the modified loan participation interest, using the pre-modification interest rate, exceeds the carrying value of the loan participation interest.

 

However, TDR concessions and classification may increase the ALPL to certain loan participation interests, such as consumer and residential real estate loans.  The concessions made to these loan participation interests often include interest rate reductions and therefore the TDR ALPL calculation results in a greater ALPL compared with the non-TDR calculation.

 

Commercial real estate loan participation interest TDRs – In instances where the Bank substantiates that it will collect the outstanding balance in full, the note is considered for return to accrual status upon the borrower sustaining sufficient cash flows for a six-month period of time. This six-month period could extend before or after the restructure date. If a charge-off was taken as part of the restructuring, any interest or principal payments received on that note are applied to first reduce the outstanding book balance and then to recoveries of charged-off principal, unpaid interest, and/or fee expenses.

 

Consumer and residential real estate loan participation interest TDRs – Modified loans identified as TDRs are aggregated into pools for analysis. Cash flows and weighted average interest rates are used to calculate impairment at the pooled-loan level. Once the loans are aggregated into the pool, they continue to be classified as TDRs until contractually repaid or charged-off.

 

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The following table presents, by class and the reason for the modification, the number of contracts, post-modification outstanding balance, and the net change in ALPL resulting from the TDR modification for the three-month period ended March 31, 2012:

 

   New Troubled Debt Restructurings During The 
   Three-Month Period Ended March 31, 2012 (1) 
       Post-modification   Net change in 
(dollar amounts in thousands)  Number of   Outstanding   ALPL resulting 
   Contracts   Balance (2)   from modification 
             
CRE - Retail properties:               
                
Interest rate reduction   1   $892   $(2)
Amortization or maturity date change            
Other            
Total CRE - Retail properties   1   $892   $(2)
                
Consumer and residential real estate secured by first-lien:               
                
Interest rate reduction   38   $4,729   $765 
Amortization or maturity date change   3    384    (1)
Other            
Total consumer and residential real estate secured by first-lien   41   $5,113   $764 
                
Consumer and residential real estate secured by second-lien:               
                
Interest rate reduction   3   $63   $3 
Amortization or maturity date change   2    47    (2)
Other            
Total consumer and residential real estate secured by second-lien   5   $110   $1 

 

(1)For the period ended March 31, 2012, there were no new troubled debt restructurings for the following classes: C&I - owner occupied, C&I - nonowner occupied, CRE - multi family, CRE - office, CRE - industrial and warehouse, and CRE - other CRE.

(2)Post-modification balances approximate pre-modification balances. The aggregate amount of charge-offs as a result of a restructuring are not significant.

 

All classes within the CRE portfolios are considered as payment redefaulted at 90-days past due. First-lien and second-lien consumer and residential real estate loan participation interests are considered as payment redefaulted at 150-days past due and 120-days past due, respectively.

 

During the three-month period ended March 31, 2012, there were no TDRs in any class of any portfolio with payment redefaults which had been modified within the previous twelve months.

 

Note 4 - Related Party Transactions

 

The Bank is required, under the Agreements, to service HPCI’s loan participation interest portfolio in a manner substantially the same as for similar work for transactions on its own behalf. The Bank collects and remits principal and interest payments, maintains perfected collateral positions, and submits and pursues insurance claims. In addition, the Bank provides accounting and reporting services to HPCI. The Bank is required to adhere to HPCI’s policies relating to the relationship between HPCI and the Bank and to pay all expenses related to the performance of the Bank’s duties under the participation and subparticipation agreements. All of these participation interests to date were acquired directly or indirectly from the Bank.

 

The Bank performs the servicing of the commercial real estate, consumer, and residential real estate loans underlying the participations held by HPCI in accordance with normal industry practice under the amended participation and subparticipation agreements. In its capacity as servicer, the Bank collects and holds the loan payments received on behalf of HPCI until the end of each month. Loan servicing costs totaled $1.6 million and $1.8 million for the three-month periods ended March 31, 2012 and 2011, respectively.

 

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In 2012 and 2011, the annual servicing rates the Bank charged with respect to outstanding principal balances were:

 

   January 1, 2011 
   through 
   March 31, 2012 
Commercial and commercial real estate   0.125%
Consumer   0.650 
Residential real estate   0.267 

 

Pursuant to the Agreements, the amount and terms of the loan servicing fee between the Bank and HPCI are determined by mutual agreement from time-to-time during the terms of the Agreements. In lieu of paying higher servicing costs to the Bank with respect to CRE loans, HPCI has waived its right to receive any origination fees associated with participation interests in CRE loans. The Bank and HPCI performed a review of loan servicing fees in 2011, and have agreed to retain current servicing rates for all loan participation categories, including the continued waiver by HPCI of its right to origination fees, until such time as servicing fees are reviewed in 2012.

 

Huntington’s and the Bank’s personnel handle day-to-day operations of HPCI such as financial analysis and reporting, accounting, tax reporting, and other administrative functions. On a monthly basis, HPCI pays the Bank and Huntington for the cost related to the time spent by employees for performing these functions. These personnel costs totaled $0.1 million for each of the three-month periods ended March 31, 2012 and 2011, and are included in other noninterest expense.

 

The following table represents the ownership of HPCI’s outstanding common and preferred securities as of March 31, 2012:

 

   Number of                 
   Common   Number of Preferred Securities 
Shareholder:  Shares   Class A   Class B   Class C   Class E 
Held by related parties:                         
HPCII   11,130,000                 
Holdings   2,870,000    895             
Tower Hill Securities, Inc.                   1,400,000 
HPC Holdings-II, Inc.           400,000         
Total held by related parties   14,000,000    895    400,000        1,400,000 
Other shareholders       105        2,000,000     
Total shares outstanding   14,000,000    1,000    400,000    2,000,000    1,400,000 

 

As of March 31, 2012, 10.5% of the Class A preferred securities were owned by current and past employees of Huntington and its subsidiaries in addition to the 89.5% owned by Holdings. The Class A preferred securities are non-voting. All of the Class B preferred securities are owned by HPC Holdings-II, Inc., a non-bank subsidiary of Huntington and are non-voting. In 2001, the Class C preferred securities were obtained by Holdings, who sold the securities to the public. Various board members and executive officers of HPCI have purchased a portion of the Class C preferred securities. At March 31, 2012, HPCI board members and executive officers beneficially owned, in the aggregate, a total of 6,971 shares, or less than 1%, of the HPCI Class C preferred securities. All of the Class E preferred securities are owned by Tower Hill Securities, Inc. In the event HPCI redeems its Class C or Class E preferred securities, holders of such securities will be entitled to receive $25.00 per share for Class C shares, $250.00 per share for Class E shares, plus any accrued and unpaid dividends on such shares. The redemption amount may be significantly lower than the then current market price of the Class C preferred securities.

 

Both the Class C and Class E preferred securities are entitled to one-tenth of one vote per share on all matters submitted to HPCI shareholders. If the Bank becomes under-capitalized, or is placed in conservatorship or receivership, the OCC may require the exchange of Class C and Class E Preferred securities for preferred securities of the Bank with substantially equivalent terms. The Class E preferred securities are currently redeemable and Class C preferred securities are redeemable at HPCI’s option on or after December 31, 2021, with prior consent of the OCC.

 

As only related parties hold HPCI’s common stock, there is no established public trading market for this class of stock.

 

HPCI had a noninterest-bearing receivable due from the Bank of $74.2 million, $40.4 million, and $34.4 million at March 31, 2012, December 31, 2011, and March 31, 2011, respectively. The balances represent the net settlement amounts due to, or from, the Bank for the last month of the period’s activity. Principal and interest payments on loan participations remitted by customers are due from the Bank, while new loan participation purchases are due to the Bank. The amounts are settled with the Bank within the first few days of the following month.

 

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HPCI has assets pledged in association with the Bank’s advances from the FHLB. For further information regarding this, see Note 6.

 

HPCI maintains and transacts all of its cash activity through the Bank. Typically, cash is invested with the Bank in an interest-bearing account. These interest-bearing balances are invested overnight or may be invested in Eurodollar deposits with the Bank for a term of not more than 30 days at market rates.

 

Note 5 - Fair Values of Assets and Liabilities

 

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are classified within one of three levels in a valuation hierarchy based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

 

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 

Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

 

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

Certain assets and liabilities may be required to be measured at fair value on a nonrecurring basis in periods subsequent to their initial recognition. These assets and liabilities are not measured at fair value on an on-going basis; however, they are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.

 

Periodically, HPCI records nonrecurring adjustments of collateral-dependent loan participation interests measured for impairment when establishing the ACL. Such amounts are generally based on the fair value of the underlying collateral supporting the loan. Appraisals are generally obtained to support the fair value of the collateral and incorporate measures such as recent sales prices for comparable properties and cost of construction. HPCI considers these fair values Level 3. In cases where the carrying value exceeds the fair value of the collateral less cost to sell, an impairment charge is recognized.

 

At March 31, 2012, HPCI identified the following loan participation interests where the carrying value exceeded the fair value of the underlying collateral for the loan. The fair value impairment for the three-month period ended March 31, 2012, was recorded within the provision for credit losses.

 

       Fair Value Measurements Using     
       Quoted Prices   Significant   Significant   Total 
       In Active   Other   Other   Gains/(Losses) 
       Markets for   Observable   Unobservable   For the Three 
   Fair Value at   Identical Assets   Inputs   Inputs   Months Ended 
(dollar amounts in thousands)  March 31, 2012   (Level 1)   (Level 2)   (Level 3)   March 31, 2012 
2012                         
Loan participation interests  $14,992   $   $   $14,992   $(149)

 

There were no changes in the valuation techniques or related inputs used to measure similar assets in prior periods.

 

Fair Value of Financial Instruments

 

The following methods and assumptions were used by HPCI to estimate the fair value of the classes of financial instruments:

 

Cash and interest-bearing deposits, and due from The Huntington National Bank — The carrying value approximates fair value based on its highly liquid nature. All amounts at March 31, 2012 and March 31, 2011 are classified as Level 1 in the valuation hierarchy.

 

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Loan participation interests — Underlying variable rate loans that reprice frequently are based on carrying amounts, as adjusted for estimated credit losses. The fair values for other loans are estimated using discounted cash flow analyses and employ interest rates currently being offered for loans with similar terms. The rates take into account the position of the yield curve, as well as an adjustment for prepayment risk, operating costs, and profit. This value is also reduced by an estimate of probable losses and the credit risk associated in the loan portfolio. As of March 31, 2012, the net carrying amount of $3.4 billion corresponded to a fair value of $3.1 billion. As of March 31, 2011, the net carrying value of $3.4 billion corresponded to a fair value of $3.0 billion. All amounts at March 31, 2012 and March 31, 2011 are classified as Level 3 in the valuation hierarchy. At March 31, 2012, the valuation of the loan portfolio reflected discounts that HPCI believed are consistent with transactions occurring in the marketplace.

 

Note 6 - Commitments and Contingencies

 

The Bank is eligible to obtain collateralized advances from various federal and government-sponsored agencies such as the FHLB. From time-to-time, HPCI may be asked to act as guarantor of the Bank’s obligations under such advances and / or pledge all or a portion of its assets in connection with those advances. Any such guarantee and / or pledge would rank senior to HPCI’s common and preferred securities upon liquidation. Accordingly, any federal or government-sponsored agencies that make advances to the Bank where HPCI has acted as guarantor or has pledged all or a portion of its assets as collateral will have a liquidation preference over the holders of HPCI’s securities. Any such guarantee and / or pledge in connection with the Bank’s advances from the FHLB falls within the definition of Permitted Indebtedness (as defined in HPCI’s Articles of Incorporation) and, therefore, HPCI is not required to obtain the consent of the holders of its common or preferred securities for any such guarantee and / or pledge.

 

Currently, HPCI’s assets have been used to collateralize only one such facility. The Bank has a line of credit from the FHLB, limited to $3.4 billion as of March 31, 2012, based on the Bank’s holdings of FHLB stock. As of this same date, the Bank had exposure of $26.9 million under the facility.

 

HPCI has entered into an Amended and Restated Agreement with the Bank with respect to the pledge of HPCI’s assets to collateralize the Bank’s borrowings from the FHLB. The agreement provides that the Bank will not place at risk HPCI’s assets in excess of an aggregate dollar amount or aggregate percentage of such assets established from time-to-time by HPCI’s board of directors, including a majority of HPCI’s independent directors. The pledge limit was established by HPCI’s board at 25% of total assets, or approximately $1.0 billion as of March 31, 2012, as reflected in HPCI’s month-end management report. This pledge limit may be changed in the future by the board of directors, including a majority of HPCI’s independent directors. The amount of HPCI’s participation interests pledged was $0.4 billion at March 31, 2012. In 2012, the loans pledged consisted of the 1-4 family residential mortgage loans. The agreement also provides that the Bank will pay HPCI a monthly fee based upon the total loans pledged by HPCI. The Bank paid HPCI a total of $0.3 million and $0.4 million for the three-month periods ended March 31, 2012 and 2011, respectively, as compensation for making such assets available to the Bank.

 

Under the terms of the participation and subparticipation agreements, HPCI is obligated to make funds or credit available to the Bank, either directly or indirectly through Holdings so that the Bank may extend credit to any borrowers, or pay letters-of-credit issued for the account of any borrowers, to the extent provided in the loan agreements underlying HPCI’s participation interests. As of March 31, 2012, December 31, 2011, and March 31, 2011, HPCI’s unfunded loan participation interest commitments totaled $207.0 million, $233.4 million, and $216.9 million, respectively.

 

Dividends

 

Based on a regulatory dividend limitation the Bank could not have declared and paid a dividend at March 31, 2012, without regulatory approval. As a subsidiary of the Bank, HPCI is also restricted from declaring or paying dividends to non-bank subsidiaries or outside shareholders without regulatory approval. The OCC has approved the payment of HPCI's dividends on its preferred securities throughout 2011 and through the 2012 second quarter. For the foreseeable future, management intends to request approval for any future dividend; however, there can be no assurance that the OCC will approve future dividends.

 

Note 7 - Segment Reporting

 

HPCI’s operations consist of acquiring, holding, and managing its participation interests. Accordingly, HPCI only operates in one segment. HPCI has no external customers and transacts all of its business with the Bank and its affiliates.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

INTRODUCTION

 

We are an Ohio corporation operating as a REIT for federal income tax purposes. Our principal business objective is to acquire, hold, and manage mortgage assets and other authorized investments that will generate net income for distribution to our shareholders.

 

We are a party to a Third Amended and Restated Loan Subparticipation Agreement with Holdings and a Second Amended and Restated Loan Participation Agreement with the Bank. The Bank is required, under the Agreements, to service our loan portfolio in a manner substantially the same as for similar work for transactions on our own behalf. The Bank collects and remits principal and interest payments, maintains perfected collateral positions, and submits and pursues insurance claims. In addition, the Bank provides to us accounting and reporting services as required. The Bank is required to adhere to our policies relating to the relationship between us and the Bank and to pay all expenses related to the performance of the Bank’s duties under the participation and subparticipation agreements. All of our participation interests to date were acquired directly or indirectly from the Bank.

 

The following discussion and analysis provides information we believe is necessary for understanding the financial condition, changes in financial condition, results of operations, and cash flows and should be read in conjunction with the financial statements, notes, and other information contained in this report. The MD&A appearing in our Form 10-K should be read in conjunction with this interim MD&A.

 

Forward-looking Statements

 

This report, including MD&A, contains certain forward-looking statements, including certain plans, expectations, goals, projections, and statements, which are subject to numerous assumptions, risks, and uncertainties. Statements that do not describe historical or current facts, including statements about beliefs and expectations, are forward-looking statements. The forward-looking statements are intended to be subject to the safe harbor provided by Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995.

 

Actual results could differ materially from those contained or implied by such statements for a variety of factors including: (1) worsening of credit quality performance due to a number of factors such as the underlying value of the collateral could prove less valuable than otherwise assumed and assumed cash flows may be worse than expected; (2) changes in economic conditions; (3) movements in interest rates; (4) competitive pressures on the Bank’s product pricing and services; (5) success, impact, and timing of the Bank’s business strategies; (6) changes in accounting policies and principles and the accuracy of our assumptions and estimates used to prepare our financial statements; (7) extended disruption of vital infrastructure; and (8) the nature, extent, and timing of governmental actions and reforms, including the Dodd-Frank Act, as well as future regulations which will be adopted by the relevant regulatory agencies, including the newly created CFPB, to implement the Dodd-Frank Act’s provisions. Additional factors that could cause results to differ materially from those described above can be found in our 2011 Form 10-K, and documents subsequently filed by us with the SEC.

 

All forward-looking statements speak only as of the date they are made and are based on information available at that time. We assume no obligation to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements were made or to reflect the occurrence of unanticipated events except as required by federal securities laws. As forward-looking statements involve significant risks and uncertainties, caution should be exercised against placing undue reliance on such statements.

 

Risk Factors

 

We are subject to a number of risks that may adversely affect our financial condition or results of operation, many of which are outside of our direct control, though efforts are made to manage those risks while optimizing returns. Credit risk related to retail properties is of particular concern in the current economy. See Credit Risk section of this report. Additionally, more information on risk is set forth under the heading “Risk Factors” included in Item 1A of Form 10-K, and subsequent filings with the SEC.

 

Critical Accounting Policies and Use of Significant Estimates

 

Our financial statements are prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires Management to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in our financial statements. Note 1 to the Financial Statements included in our 2011 Form 10-K as supplemented by this report lists significant accounting policies used by Management in the development and presentation of our financial statements. This MD&A, the significant accounting policies, and other financial statement disclosures identify and address key variables and other qualitative and quantitative factors that are necessary for an understanding and evaluation of us and our financial position, results of operations, and cash flows.

 

26
 

 

An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements if a different amount within a range of estimates was used or if estimates changed from period-to-period. Estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that significantly differ from when those estimates were made.

 

Our most significant accounting estimates relate to our ACL. This significant accounting estimate and related application is discussed in our 2011 Form 10-K. The related fair value measurement on a nonrecurring basis can be found in Note 5 of Notes to the Unaudited Condensed Financial Statements.

 

QUALIFICATION TESTS

 

Qualification as a REIT involves application of specific provisions of the IRC relating to various asset tests. A REIT must satisfy six asset tests quarterly: (1) 75% of the value of the REIT's total assets must consist of real estate assets, cash and cash items, and government securities; (2) not more than 25% of the value of the REIT's total assets may consist of securities, other than those includible under the 75% test; (3) not more than 5% of the value of its total assets may consist of securities of any one issuer, other than those securities includible under the 75% test or securities of taxable REIT subsidiaries; (4) not more than 10% of the outstanding voting power of any one issuer may be held, other than those securities includible under the 75% test or securities of taxable REIT subsidiaries; (5) not more than 10% of the total value of the outstanding securities of any one issuer may be held, other than those securities includible under the 75% test or securities of taxable REIT subsidiaries; and (6) a REIT cannot own securities in one or more taxable REIT subsidiaries which comprise more than 20% of its total assets. At March 31, 2012, we met all of the quarterly asset tests.

 

Also, a REIT must annually satisfy two gross income tests: (1) 75% of its gross income must be from qualifying income closely connected with real estate activities; and (2) 95% of its gross income must be derived from sources qualifying for the 75% test plus dividends, interest, and gains from the sale of securities. In addition, a REIT must distribute 90% of the REIT’s taxable income for the taxable year, excluding any net capital gains, to maintain its nontaxable status for federal income tax purposes. For the tax year 2011, we met all annual income and distribution tests.

 

We operate in a manner that will not cause us to be deemed an investment company under the Investment Company Act. The Investment Company Act exempts from registration as an investment company an entity that is primarily engaged in the business of purchasing or otherwise acquiring mortgages and other liens on and interests in real estate (Qualifying Interests). Under positions taken by the SEC staff in no-action letters, in order to qualify for this exemption, we must invest at least 55% of our assets in Qualifying Interests and an additional 25% of our assets in real estate-related assets, although this percentage may be reduced to the extent that more than 55% of our assets are invested in Qualifying Interests. The assets in which we may invest under the IRC therefore may be further limited by the provisions of the Investment Company Act and positions taken by the SEC staff. At March 31, 2012, we were exempt from registration as an investment company under the Investment Company Act and we intend to operate our business in a manner that will maintain this exemption.

 

RESULTS OF OPERATIONS

 

Our income is primarily derived from our participation in loans acquired from the Bank and Holdings. Income varies based on the level of these assets and their respective interest rates. The cash flows from these assets are used to satisfy our preferred dividend obligations. The preferred stock is considered equity and, therefore, the dividends are not reflected as interest expense.

 

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The following table details the results of operations for the last five quarters. The $1.3 million decrease in net income for the 2012 first quarter, compared with same period in 2011, was primarily the result of lower interest and fee income and a decreased reduction in the allowance for credit losses.

 

Table 1 - Selected Quarterly Income Statement Data
   2012   2011   1Q12 vs. 1Q11 
(dollar amounts in thousands)  First   Fourth   Third   Second   First   $ chg   %Chg 
Interest and fee income                                   
Interest on loan participation interests:                                   
Commercial real estate  $28,583   $29,135   $28,732   $27,774   $27,356   $1,227    4%
Consumer and residential real estate   6,625    7,393    7,833    8,262    8,830    (2,205)   (25)
Total loan participation interest income   35,208    36,528    36,565    36,036    36,186    (978)   (3)
Fees from loan participation interests   245    396    297    320    369    (124)   (34)
Interest on deposits with the Bank   174    181    148    169    156    18    12 
Total interest and fee income   35,627    37,105    37,010    36,525    36,711    (1,084)   (3)
Provision (reduction in                                   
allowance) for credit losses   (16,126)   (7,352)   (23,067)   9,255    (16,365)   239    (1)
Interest income after provision (reduction                                   
in allowance) for credit losses   51,753    44,457    60,077    27,270    53,076    (1,323)   (2)
Noninterest income:                                   
Rental income   18    17    18    17    18        - 
Collateral fees   326    353    371    398    420    (94)   (22)
Total noninterest income   344    370    389    415    438    (94)   (21)
                                    
Noninterest expense:                                   
Servicing costs   1,645    1,689    1,732    1,750    1,787    (142)   (8)
Other   159    181    175    186    164    (5)   (3)
Total noninterest expense   1,804    1,870    1,907    1,936    1,951    (147)   (8)
Net income  $50,293   $42,957   $58,559   $25,749   $51,563   $(1,270)   (2)%
Dividends declared on preferred shares   3,578    3,114    2,867    2,971    3,054    524    17 
Net income applicable to common shares(1)  $46,715   $39,843   $55,692   $22,778   $48,509   $(1,794)   (4)%

  

(1)All of HPCI's common stock is owned by HPCII and Holdings and, therefore, net income per share is not presented.

 

Interest and Fee Income

 

Our primary source of revenue is interest and fee income on our participation interests in loans. At March 31, 2012 and 2011, we did not have any interest-bearing liabilities or related interest expense. Interest income is impacted by changes in the levels of interest rates and earning assets. The yield on earning assets is the percentage of interest income to average earning assets.

 

The tables below show our average balances, interest and fee income, and yields for the three and three-month periods ended March 31, 2012 and 2011:

 

Table 2 - Quarterly Interest and Fee Income

 

   Three Months Ended March 31, 
   2012   2011 
(dollar amounts in millions)  Average Balance   Income(1)   Yield   Average Balance   Income(1)   Yield 
Loan participation interests:(2)                              
Commercial real estate  $3,125.4   $28.8    3.71%  $2,940.6   $27.6    3.82%
Consumer and residential real estate   421.0    6.6    6.35    546.8    8.9    6.58 
Total loan participation interests   3,546.4    35.4    4.02    3,487.4    36.5    4.25 
Interest-bearing deposits in the Bank   275.2    0.2    0.25    207.5    0.2    0.30 
Total  $3,821.6   $35.6    3.75%  $3,694.9   $36.7    4.03%

 

(1)Income includes interest and fees.

(2)For the purposes of this analysis, average balances include nonaccrual loans.

 

Interest and fee income was $35.6 million for the three-months ended March 31, 2012 compared with $36.7 million for the year ago quarter. As shown in Table 2, the decrease in interest and fee income was the result of a decrease in yields on loan participation interests. For the three-months ended March 31, 2012, the loan yield decreased 23 basis points to 4.02%, while average loan participation interest balances increased $59.0 million, or 2% compared to the year-ago quarter.

 

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At March 31, 2012, December 31, 2011, and March 31, 2011, approximately 78%, 75%, and 76%, respectively, of the portfolio was comprised of variable interest rate loan participations. The table above includes interest received on participations in loans that are on nonaccrual status in the individual portfolios.

 

Provision (reduction in allowance) for credit losses

 

The provision (reduction in allowance) for credit losses is the charge (credit) to earnings necessary to maintain the ACL at a level appropriate to absorb our estimate of inherent probable losses in the loan portfolio. Loan participations are acquired net of related ALPL. As a result, this ALPL is transferred to HPCI from the Bank and is reflected as ALPL acquired, rather than HPCI having to record a provision expense for ALPL. If credit quality deteriorates more than implied by the ALPL acquired, a provision to the ALPL is made. If credit quality performance is better than implied by the ALPL acquired, an ALPL reduction is recorded. As loan participations mature, refinance, or other such actions occur, any allowance not absorbed by loan losses is released through the reduction in ALPL.

 

Such adjustments in the 2012 first quarter resulted in a reduction in allowance for credit losses of $16.1 million compared to a reduction in allowance for credit losses of $7.4 million in the prior quarter and $16.4 million in the year-ago quarter. See ACL discussion within the Credit Quality section.

 

Noninterest Income and Noninterest Expense

 

Noninterest income for the 2012 first quarter was $0.3 million compared with $0.4 million in the year-ago quarter. Noninterest income includes fees from the Bank for use of our assets as collateral for the Bank’s advances from the FHLB. For the 2012 first quarter, these fees totaled $0.3 million, compared with $0.4 million for the prior year quarter. See Note 6 to the Unaudited Financial Statements included in this report for more information regarding the use of our assets as collateral for the Bank’s advances from the FHLB.

 

Noninterest expense for the 2012 first quarter was $1.8 million compared with $2.0 million in the year-ago quarter. The predominant component of noninterest expense is the fee paid to the Bank for servicing the loans underlying the participation interests. For the 2012 first quarter, servicing costs amounted to $1.6 million, compared with $1.8 million for the year-ago quarter. The decrease in the servicing costs from the comparable periods reflected lower residential real estate and consumer loan balances which have higher servicing costs. The annual servicing rates the Bank charged with respect to outstanding principal balances in 2012 and 2011 were:

 

   January 1, 2011 
   through 
   March 31, 2012 
Commercial and commercial real estate   0.125%
Consumer   0.650 
Residential real estate   0.267 

 

Pursuant to the Agreements, the amount and terms of the loan-servicing fee between the Bank and us are determined by mutual agreement from time to time during the terms of the Agreements. In lieu of paying higher servicing costs to the Bank with respect to CRE loans, we waive our right to receive any origination fees associated with participation interests in CRE loans. We, along with the Bank, performed a review of loan servicing fees in 2011, and agreed to retain current servicing rates for all loan participation categories, including the continued waiver by us of our right to origination fees, until such time as servicing fees are reviewed in 2012.

 

Provision for Income Taxes

 

We have elected to be treated as a REIT for federal income tax purposes and intend to maintain compliance with the provisions of the IRC and, therefore, are not subject to federal income taxes. Thus, we had no provision for income taxes for the first three-month periods of 2012 and 2011.

 

We are included in certain of Huntington’s consolidated state income and franchise tax returns. On March 8, 2012, our board of directors adopted Huntington’s Policy Statement on Intercorporate State Tax Allocation, dated January 1, 2012.  As a result, beginning in 2012, Huntington’s consolidated state tax provision will be allocated to its separate subsidiary companies, including us, on the basis of separate return computations. Under its tax-sharing agreement with Huntington, we will provide and remit state taxes to or receive a state tax benefit from Huntington or the tax paying member. For the first three-month periods of 2012 and 2011, we had no state provision for income taxes.

 

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RISK MANAGEMENT AND CAPITAL

 

Risk awareness, identification and assessment, reporting, and active management are key elements to overall risk management. The Bank manages risk to an aggregate moderate-to-low risk profile strategy through a control framework and by monitoring and responding to potential risks. Controls include, among others, effective segregation of duties, access, authorization and reconciliation procedures, as well as staff education and a disciplined assessment process. Management relies on the Bank’s credit management controls, processes, and procedures in evaluating and responding to risk within the loan participation interest portfolio.

 

Credit Risk

(This section should be read in conjunction with Note 3 of Notes to the Unaudited Condensed Financial Statements.)

 

Credit risk is the risk of financial loss if a counterparty is not able to meet the agreed upon terms of the financial obligation. The significant change in the economic conditions and the resulting changes in borrower behavior over the past several years resulted in the focusing of significant resources to the identification, monitoring, and managing of credit risk. In addition to the traditional credit risk mitigation strategies of credit policies and processes, market risk management activities, and portfolio diversification, additional quantitative measurement capabilities were implemented that utilize external data sources, enhanced use of modeling technology, and internal stress testing processes.

 

Under the Agreements, the Bank may, in accordance with our guidelines, dispose of any underlying loan participation interest that is rated as Substandard or lower, is placed in a nonaccrual status, or is renegotiated due to the financial deterioration of the borrower. The Bank may, in accordance with our guidelines, institute foreclosure proceedings, exercise any power of sale contained in any mortgage or deed of trust, obtain a deed in lieu of foreclosure, or otherwise acquire title to a property underlying a mortgage loan by operation of law or otherwise in accordance with the terms of the Agreements. Prior to completion of foreclosure or liquidation, the loan participation interest is sold to the Bank at fair market value. The Bank then incurs all costs associated with repossession and foreclosure.

 

Loan Participation Interest Credit Exposure Mix

 

At March 31, 2012, CRE loan participation interests were 88% of total loan participation interests compared with 85% at March 31, 2011. Total consumer and residential real estate loan participation interests were 12% of total loan participation interests at March 31, 2012, compared with 15% at March 31, 2011. The change in the portfolio mix over the past 12 months reflects not purchasing any new consumer and residential real estate loan participation interests during this period.

 

Commercial Real Estate Credit

 

CRE loan credit approvals are made by the Bank and are based on, among other factors, the financial strength of the borrower, assessment of the borrower’s management capabilities, appraised collateral value, industry sector trends, type of exposure, transaction structure, and the general economic outlook.

 

In commercial lending, on-going credit management is dependent on the type and nature of the loan. The Bank monitors all significant credit extensions on an on-going basis. All commercial credit extensions are assigned internal risk ratings reflecting the borrower’s PD and LGD (severity of loss). This two-dimensional rating methodology provides granularity in the portfolio management process. The PD is rated and applied at the borrower level. The LGD is rated and applied based on the type of credit extension and the quality and lien position associated with the underlying collateral. The internal risk ratings are assessed at origination and updated with each periodic monitoring event. There is also extensive macro portfolio management analysis on an on-going basis. The Bank continually reviews and adjusts the risk-rating criteria based on actual experience, which provides the current risk level in the portfolio, and is the basis for determining an appropriate ACL amount for the portfolio.

 

In addition to the initial credit analysis initiated during the approval process, the Bank’s Credit Review group performs testing to provide an independent review and assessment of the quality and / or risk of new loan originations. This group is part of the Bank’s Risk Management area, and conducts portfolio reviews on a risk-based cycle to evaluate individual loans, validate risk ratings, as well as test the consistency of credit processes.

 

The standardized loan grading system considers many components that directly correlate loan quality and likelihood of repayment, one of which is guarantor support. On an annual basis, or more frequently if warranted, we consider, among other things, the guarantor’s reputation and creditworthiness, along with various key financial metrics such as liquidity and net worth, assuming such information is available. Our assessment of the guarantor’s credit strength, or lack thereof, is reflected in the risk ratings for such loans. The risk ratings are directly tied to, and an integral component of, the ALPL methodology. When a loan participation interest goes to impaired status, viable guarantor support is considered in the determination of the recognition of loan participation interest loss. If the assessment of the guarantor’s credit strength yields an inherent capacity to perform, we will seek repayment from the guarantor as part of the collection process and have done so successfully. However, the repayment success from guarantors is not formally tracked.

 

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Substantially all CRE loans categorized as Classified (see Note 3 of Notes to Unaudited Condensed Financial Statements) are managed by the Bank’s SAD. The SAD is a specialized credit group that handles the day-to-day management of workouts, commercial recoveries, and problem loan sales. Its responsibilities include developing action plans, assessing risk ratings, and determining the appropriateness of the allowance, the accrual status, and the ultimate collectability of the Classified loan participation interest portfolio.

 

The CRE portfolio is diversified by customer size, as well as geographically throughout the Bank’s footprint. No outstanding CRE loan participation interests comprised an industry or geographic concentration of lending. CRE loan participation interests outstanding by property type and borrower location at March 31, 2012, were as follows:

 

Table 3 - Commercial Real Estate Loan Participation Interests by Property Type and Borrower Location

 

   March 31, 2012 
(dollar amounts in thousands)  Ohio   Michigan   Indiana   Pennsylvania   Kentucky   Other   Total Amount   % 
                                 
Industrial and warehouse  $430,674   $198,339   $50,624   $16,583   $18,657   $16,842   $731,719    24%
Retail properties   376,387    101,806    57,691    26,188    13,820    76,804    652,696    21 
Office   322,265    73,136    16,133    69,682    15,511    24,590    521,317    17 
Multi family   126,979    19,061    29,840    10,844    25,151    11,506    223,381    7 
Other commercial real estate   541,741    233,994    35,197    30,547    34,172    79,789    955,440    31 
Total  $1,798,046   $626,336   $189,485   $153,844   $107,311   $209,531   $3,084,553    100%
                                         
% of total portfolio   58%   20%   6%   5%   3%   8%   100%     

 

As shown in the table above, we had $3.1 billion of CRE loan participation interests at March 31, 2012. CRE loan participation interests are diversified by customer size, as well as customer location throughout the Bank’s lending area of Ohio, Michigan, Indiana, Kentucky, and Pennsylvania.

 

Consumer and Residential Real Estate Credit

 

Consumer credit approvals by the Bank are based on, among other factors, the financial strength and payment history of the borrower, type of exposure, and the transaction structure. Consumer credit decisions are generally made in a centralized environment utilizing decision models.

 

The consumer and residential real estate portfolio is primarily located throughout the Bank’s geographic footprint. The continued stress on home prices has caused the performance in this portfolio to remain weaker than historical levels.

 

Credit Quality

 

Credit quality performance during the 2012 first quarter, reflected an improvement compared to the 2011 fourth quarter, as NCOs and NPAs declined. Also, the ACL coverage ratio of NPAs increased to 191% at March 31, 2012, compared with 215% at March 31, 2011.

 

NPAs

 

NPAs consist of loan participation interests in underlying loans that are no longer accruing interest. Any loan participation interest in our portfolio may be placed on nonaccrual status prior to the policies described below when collection of principal or interest is in doubt.

 

Underlying CRE loan participation interests are placed on nonaccrual status at 90-days past due. Underlying first-lien loan participation interests in consumer and residential real estate loans are placed on nonaccrual status at 150-days past due. Second-lien loan participation interests in consumer and residential real estate loans are placed on nonaccrual status at the earlier of 120-days past due or when the related first-lien loan has been identified as nonaccrual. When interest accruals are suspended, accrued interest income is reversed with current year accruals charged to earnings and prior year amounts generally charged-off as a credit loss. When, in Management’s judgment, the borrower’s ability to make required principal and interest payments has resumed and collectability is no longer in doubt, the loan participation interest is returned to accrual status.

 

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The following table shows NPAs at the end of the most recent five quarters:

 

Table 4 - Quarterly Nonperforming Assets

 

   2012   2011 
(dollar amounts in thousands)  March 31,   December 31,   September 30,   June 30,   March 31, 
                     
Participation interest in nonaccrual assets:                         
Commercial real estate  $31,714   $45,485   $54,150   $65,062   $40,849 
Consumer and residential real estate   5,681    6,097    6,706    5,916    4,406 
Total nonperforming assets  $37,395   $51,582   $60,856   $70,978   $45,255 
                          
Accruing loan participation interests past due 90 days or more  $2,318   $4,208   $3,261   $2,710   $3,215 
                          
NPAs as a % of total loan participation interests   1.07%   1.44%   1.71%   2.00%   1.29%
ALPL as a % of NPAs   189    162    153    159    212 
ACL as a % of NPAs   191    164    154    160    215 

 

The $14.2 million, or 28%, decrease in total NPAs compared with December 31, 2011, was centered in the commercial real estate portfolio and reflects the impacts of NCO and problem credit resolutions, as well as the sale of one large CRE NPA.

 

ACL

We maintain two reserves, both of which are available to absorb credit losses inherent in the loan participation interests portfolio: the ALPL and the AULPC. When summed together, these reserves constitute the total ACL. Additions to the ALPL and AULPC result primarily from the transfer of the ACL associated with purchased loan participation interests at Huntington’s carrying value between entities under common control.

 

The following table shows the activity in HPCI’s ALPL and AULPC for the last five quarters ended March 31, 2012:

 

Table 5 - Allowance for Credit Loss Activity

 

   2012   2011 
(dollar amounts in thousands)  First   Fourth   Third   Second   First 
                     
ALPL balance, beginning of period  $83,772   $92,899   $112,514   $95,866   $110,103 
Allowance of loan participation interests acquired   4,942    8,292    12,705    16,689    8,519 
Net charge-offs:                         
Commercial real estate   (148)   (8,113)   (6,251)   (7,899)   (4,040)
Consumer and residential real estate   (1,908)   (1,919)   (2,836)   (2,146)   (2,366)
Total net charge-offs   (2,056)   (10,032)   (9,087)   (10,045)   (6,406)
Provision (reduction in allowance) for loan participation interest losses   (15,936)   (7,387)   (23,233)   10,004    (16,350)
ALPL balance, end of period  $70,722   $83,772   $92,899   $112,514   $95,866 
AULPC balance, beginning of period  $1,035   $1,000   $834   $1,583   $1,598 
Provision (reduction in allowance) for unfunded loan participation commitment losses   (190)   35    166    (749)   (15)
AULPC balance, end of period  $845   $1,035   $1,000   $834   $1,583 
Total allowance for credit losses, end of period  $71,567   $84,807   $93,899   $113,348   $97,449 
ALPL as a % of total loan participation interests   2.03%   2.34%   2.61%   3.17%   2.74%
ACL as a % of total loan participation interests   2.05    2.37    2.64    3.20    2.78 

 

The ACL decreased $13.2 million to $71.6 million at March 31, 2012, compared with $84.8 million at December 31, 2011. The decrease in the ACL was the result of an improvement in credit quality in the CRE portfolio, reflecting lower NCOs as well as a decrease in specific reserves.

 

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The ACL to total loan participation interests declined to 2.05% at March 31, 2012 compared to 2.37% at December 31, 2011, and it is believed the decline in the ratio is appropriate given the continued improvement in the risk profile of the loan participation interest portfolio. However, the overall economic conditions improved only slightly in the 2012 first quarter and the residential real estate market remained stressed. The overall economic conditions have shown some recent improvement, but risks to a full recovery remain, including the European economic instability, continued budget issues in local governments, flat domestic economic growth, and the variety of policy proposals regarding job growth, debt management, and domestic tax policy. Continued high unemployment, among other factors, has slowed any significant recovery. In the near-term, Management anticipates a continued high unemployment rate and the concern around the U.S. and local government budget issues will continue to negatively impact the financial condition of some retail and commercial borrowers.

 

The pronounced downturn in the residential real estate market that began in early 2007 has resulted in significantly lower residential real estate values. The impact of the downturn in real estate values has had a significant impact on some borrowers as evidenced by the higher delinquencies and NCOs since late 2007. Management does not anticipate any meaningful improvement in real estate values in the near-term. Given the combination of these noted factors, Management believes that our ACL is appropriate and its coverage level is reflective of the quality of the portfolio and the current operating environment.

 

NCOs

 

Any loan participation interest in any portfolio may be charged-off prior to the policies described below if a loss confirming event has occurred. Loss confirming events include, but are not limited to, bankruptcy (unsecured), continued delinquency, foreclosure, or receipt of an asset valuation indicating a collateral deficiency and that asset is the sole source of repayment.

 

CRE loan participation interests are either charged-off or written down to net realizable value at 90-days past due. First-lien and second-lien consumer and residential real estate loan participation interests are charged-off to the estimated fair value of the collateral at 150-days past due and 120-days past due, respectively.

 

The table below reflects NCO detail for each of the last five quarters:

 

Table 6 - Net Charge-offs (1)

 

   2012   2011 
(dollar amounts in thousands)  March 31,   December 31,   September 30,   June 30,   March 31, 
                                         
Commercial real estate  $148    0.02%  $8,113    1.03%  $6,251    0.80%  $7,899    1.05%  $4,040    0.55%
Consumer and residential real estate   1,908    1.81    1,919    1.68    2,836    2.33    2,146    1.67    2,366    1.73 
Total net charge-offs  $2,056    0.23%  $10,032    1.11%  $9,087    1.00%  $10,045    1.14%  $6,406    0.73%

 

(1) Percentages represent the annualized percentage of related average loan participation interests.

 

2012 first quarter NCOs declined $8.0 million, or 80%, compared to the prior quarter and $4.4 million, or 68%, compared to the first three-month period of 2011. These declines primarily reflected a decline in CRE NCOs as a result of improvement in the underlying credit quality of the portfolio in addition to a recovery related to a relatively large commercial loan participation interest during the first quarter of 2012. We expect some quarterly volatility related to NCOs given the absolute low level and the uncertain and uneven nature of the economic recovery.

 

Market Risk

 

The predominate market risk to which we are exposed is the risk of loss due to a decline in interest rates. If there is a decline in market interest rates, we may experience a reduction in interest income from our loan participation interests and a corresponding decrease in funds available to be distributed to shareholders. When rates rise, we are exposed to declines in the economic value of equity since only approximately 22% of our loan participation portfolio is fixed rate.

 

Huntington conducts its monthly interest rate risk management on a centralized basis and does not manage our interest rate risk separately. Two broad approaches to modeling interest rate risk are employed: income simulation and economic value analysis. An income simulation analysis was used to measure the sensitivity of forecasted interest income to changes in market rates over a 12-month period. The economic value analysis was conducted by subjecting the period-end balance sheet to changes in interest rates and measuring the impact of the changes in the value of the assets. The models used for these measurements assume, among other things, no new loan participation volume.

 

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The simulations for evaluating interest income sensitivity exposure are scenarios that model gradual +/-200 basis points parallel shifts in market interest rates over the next one-year period beyond the interest rate change implied by the current yield curve. The table below shows the results of the scenarios as of March 31, 2012, and March 31, 2011. The interest income sensitivity reported as of March 31, 2012, for the +200 basis points scenario shows a more asset sensitive interest rate risk position compared with March 31, 2011.

 

Table 7 - Interest Income Sensitivity

 

   Change in Interest Income
for a Given
 
   Change in Interest Rates 
(dollar amounts in millions)  Over / (Under) Base Case
Parallel Ramp
 
Basis point change scenario   -200(1)   +200  
March 31, 2012          
Net interest income  $-5.8   $16.9 
Percentage change   -5.8%   16.9%
           
March 31, 2011          
Net interest income  $-4.0   $14.4 
Percentage change   -3.8%   14.0%

 

(1) The gradual 200 basis point decline in market rates assumes market interest rates would reach a bottom and not fall below 0%.

 

The primary simulations for EVE at risk assume immediate +/-200 basis points parallel shifts in market interest rates beyond the interest rate change implied by the current yield curve. The table below outlines the March 31, 2012 results compared with March 31, 2011. The economic value sensitivity risk reported as of March 31, 2012, for the +200 basis points scenario shows a lower long-term liability sensitive position compared with March 31, 2011.

 

Table 8 - Economic Value Sensitivity    
         
   Change in Economic Value for a Given 
   Change in Interest Rates 
(dollar amounts in millions)  Over / (Under) Base Case Parallel Shocks 
Basis point change scenario   -200(1)   +200  
March 31, 2012          
Fair value of loan participation interests  $11.1   $-37.1 
Percentage change   0.3%   -1.0%
           
March 31, 2011          
Fair value of loan participation interests  $22.4   $-48.8 
Percentage change   0.6%   -1.3%

 

(1) The gradual 200 basis point decline in market rates assumes market interest rates would reach a bottom and not fall below 0%.

 

Off-Balance Sheet Arrangements

 

Under the terms of the Agreements, we are obligated to make funds or credit available to the Bank, either directly or indirectly through Holdings so that the Bank may extend credit or pay letters-of-credit issued for the account of any borrowers, to the extent provided in the loan agreements underlying our participation interests. At March 31, 2012, December 31, 2011, and March 31, 2011, HPCI’s unfunded loan participation interest commitments totaled $207.0 million, $233.4 million, and $216.9 million, respectively. It is expected that the existing cash balances and cash flows generated by the existing portfolio will be sufficient to meet these obligations.

 

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Liquidity And Capital Resources

 

The objective of our liquidity management is to ensure the availability of sufficient cash flows to fund our existing loan participation commitments, to acquire additional participation interests, and to pay operating expenses and dividends. Unfunded commitments and additional participation interests in loans are funded with the proceeds from repayment of principal balances by individual borrowers, utilization of existing cash and cash equivalent funds, and if necessary, new capital contributions. Payment of operating expenses and dividends will be funded through cash generated by operations.

 

In managing liquidity, we take into account forecasted principal and interest payments on loan participations as well as various legal limitations placed on a REIT. To the extent that additional funding is required, we may raise such funds through retention of cash flow, debt financings, additional equity offerings, or a combination of these methods. However, any cash flow retention must be consistent with the provisions of the IRC requiring the distribution by a REIT of at least 90% of its REIT taxable income, excluding capital gains, and must take into account taxes that would be imposed on undistributed income.

 

At March 31, 2012, December 31, 2011, and March 31, 2011, we maintained cash and interest-bearing balances with the Bank totaling $325.6 million, $229.0 million, and $210.1 million, respectively. We maintain and transact all of our cash activity with the Bank and may invest available funds in Eurodollar deposits with the Bank for a term of not more than 30 days at market rates.

 

At March 31, 2012, we had no material liabilities or contractual obligations, other than unfunded loan participation interest commitments of $207.0 million, with a weighted average remaining maturity of 1.36 years. In addition to anticipated cash flows, as noted above, we have cash and interest bearing balances with the bank totaling $325.6 million to supplement the funding of these liabilities and contractual commitments.

 

As of March 31, 2012 and December 31, 2011, shareholders’ equity was $3.8 billion. Shareholders’ equity as of March 31, 2011, was $3.7 billion.

 

Regulatory approval is required prior to the Bank’s declaration of any dividends in excess of available retained earnings. Based on a regulatory dividend limitation, the Bank could not have declared and paid a dividend at March 31, 2012, without regulatory approval. As a subsidiary of the Bank, we are also restricted from declaring or paying dividends without regulatory approval. The OCC has approved the payment of dividends on our Class A, B, and C Preferred securities throughout 2011 and through the 2012 second quarter. For the foreseeable future, Management intends to request approval for any future dividends; however, there can be no assurance that the OCC will approve future Class A, B, and C Preferred dividends.

 

Regulatory capital ratios are the primary metrics used by regulators in assessing the safety and soundness of banks. At March 31, 2012, Huntington and the Bank met all capital adequacy requirements and had regulatory capital ratios in excess of the levels established for well-capitalized institutions. The capital ratios for Huntington and the Bank at the end of the most recent five quarters are as follows:

 

Table 9 - Regulatory Capital Ratios                    
                     
   2012   2011 
   March 31,   December 31,   September 30,   June 30,   March 31, 
Tier 1 leverage ratio (5.00% Well-capitalized)                         
Huntington   10.55%   10.28%   10.24%   10.25%   9.80%
Bank   8.24    7.89    7.79    7.62    7.23 
Tier 1 risk-based capital ratio (6.00% Well-capitalized)                         
Huntington   12.22    12.11    12.37    12.14    12.04 
Bank   9.54    9.30    9.40    9.01    8.87 
Total risk-based capital ratio (10.00% Well-capitalized)                         
Huntington   14.76    14.77    15.11    14.89    14.85 
Bank   12.49    12.60    13.54    13.17    13.11 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Quantitative and qualitative disclosures for the current period can be found in the Market Risk section of this report, which includes material changes in market risk exposures from disclosures presented in HPCI's Form 10-K.

 

35
 

 

Item 4. Controls and Procedures

 

HPCI maintains disclosure controls and procedures designed to ensure that the information disclosed in its filings with the Securities and Exchange Commission is recorded, processed, summarized, and reported appropriately and on a timely basis. HPCI's management, with the participation of its President (principal executive officer) and the Vice President (principal financial officer), evaluated the effectiveness of HPCI’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon such evaluation, HPCI's President and Vice President have concluded that, as of the end of such period, HPCI's disclosure controls and procedures are effective.

 

There have not been any changes in HPCI’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2012, to which this report relates, that have materially affected, or are reasonably likely to materially affect, HPCI's internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

In accordance with the instructions to Part II, the other specified items in this part have been omitted because they are not applicable or the information has been previously reported.

 

Item 6. Exhibits

 

This report incorporates by reference the documents listed below that HPCI has previously filed with the SEC. The SEC allows incorporation by reference in this document. The information incorporated by reference is considered to be a part of this document, except for any information that is superseded by information that is included directly in this document.

 

This information may be read and copied at the Public Reference Room of the SEC at 100 F Street, N.E., Washington, D.C. 20549. The SEC also maintains an Internet web site that contains reports, proxy statements, and other information about issuers, like HPCI, who file electronically with the SEC. The address of the site is http://www.sec.gov. The reports and other information filed by HPCI with the SEC are also available at Huntington’s Internet web site. The address of the site is http://www.huntington.com. Except as specifically incorporated by reference into this Quarterly Report on Form 10-Q, information on those web sites is not part of this report. Reports, proxy statements, and other information about HPCI can also be inspected at the offices of the NASDAQ National Market at 33 Whitehall Street, New York, New York.

  

3.1.Second Amended and Restated Articles of Incorporation (previously filed as Exhibit 3.1 to Current Report on Form 8-K (File No. 000-33243), filed with the Securities and Exchange Commission on November 2, 2010, and incorporated herein by reference.)

 

3.2.Code of Regulations (previously filed as Exhibit 3(b) to the Registrant's Registration Statement of Form S-11 (File No. 333-61182), filed with the Securities and Exchange Commission on May 17, 2001, and incorporated herein by reference.)

 

4.1Specimen of certificate representing Class C preferred securities, previously filed as Exhibit 4 to the Registrant's Amendment No. 1 to Registration Statement of Form S-11 (File No. 333-61182), filed with the Securities and Exchange Commission on May 31, 2001, and incorporated herein by reference.

 

31.1.Rule 13a – 14(a) Certification – President (chief executive officer).

 

31.2.Rule 13a – 14(a) Certification – Vice President (chief financial officer).

 

32.1.Section 1350 Certification – President (chief executive officer).

 

32.2.Section 1350 Certification – Vice President (chief financial officer).

 

99.1.Unaudited Condensed Consolidated Financial Statements of Huntington Bancshares Incorporated as of and for the three-month periods ended March 31, 2012 and 2011.

 

101**The following material from HPCI’s Form 10-Q Report for the quarterly period ended March 31, 2012, formatted in XBRL: (i) Unaudited Condensed Balance Sheets, (ii) Unaudited Condensed Statements of Comprehensive Income, (iii) Unaudited Condensed Statements of Changes in Shareholders’ Equity, (iv) Unaudited Condensed Statements of Cash Flows, and (v) the Notes to Unaudited Condensed Financial Statements.

 

** Furnished, not filed.

 

36
 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on the 14th day of May, 2012.

 

HUNTINGTON PREFERRED CAPITAL, INC.

(Registrant)

 

By: /s/ Donald R. Kimble   By: /s/ David S. Anderson
  Donald R. Kimble     David S. Anderson
  President and Director     Vice President and Director
  (Principal Executive Officer)     (Principal Financial and Accounting Officer)

 

37

 

XNAS:HPCCP Quarterly Report 10-Q Filling

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