We have downgraded our recommendation on Huntington Bancshares Inc. (HBAN) to Underperform from Neutral as we do not expect any substantial improvement in the top line in the first half of 2011 since economic growth is still in its nascent stage.

In January, Huntington reported fourth quarter 2010 profit of 5 cents per share. Results came in below the Zacks Consensus Estimate of 8 cents per share. The results, however, included a one-time reduction of 7 cents per share for the deemed dividend resulting from the repurchase of $1.4 billion in TARP capital in December.

Quarterly results at Huntington reflect a significant reduction in loan loss provisions and better-than-expected growth in revenue. Nonperforming assets and net charge-offs continued to decline.

The year 2010 has been one of turnaround for Huntington. The company, which was once plagued by significant souring loans and problem assets, was able to return to profitability in 2010. In full-year 2010, Huntington reported net income of $312.3 million or 19 cents per share compared to a net loss of $3.1 billion or $6.14 per share in 2009.

For a prolonged period, if short-term interest rates remain at their historically low levels and longer term interest rates fall further, Huntington would experience net interest margin (NIM) compression as interest earning assets would continue to reprice downward. This would have an adverse effect on net interest income and results of operations.

Regulatory issues will remain a concern and its fee income is expected to remain pressured in the near term. Though management has taken precautionary measures, the amendment of the Reg E (overdraft legislation) would restrict the company’s revenue from overdraft charges.

In December 2010, Huntington repurchased all $1.4 billion of the Series B Fixed Rate Cumulative Perpetual Preferred Stock that it issued to the Treasury as a part of Troubled Asset Relief Program (TARP). The company also bought back the warranties it had issued to the Treasury for $49.1 million. The company issued $920 million of common stock and $300 million of subordinated debt and used the net proceeds coupled with existing cash for the bailout repayment. Besides Huntington, another regional bank – First Horizon National Corp. (FHN) also repaid its TARP dues in December.

The TARP repayment is a positive factor for the company. While the stock offering would have a dilutive impact, the company will not have to pay the TARP dividends any longer.

From an earnings perspective, Huntington expects this to be a transitional year. The company projects its 2011 pre-tax, pre-provision income to remain relatively stable with that of the second half of 2010, or about $260–$265 million per quarter and anticipates a return to growth in 2012, if not earlier.

Huntington expects net income to improve in 2011, primarily on a reduction in provision for credit losses. Absolute levels of net charge-offs, non-performing assets, and criticized loans will continue to decline, thereby reducing provision expense. Additionally, earnings might benefit from a growth in net interest income.

While the above expectations are encouraging, revenue headwinds driven by regulatory and legislative actions remain concerns. Fee income is anticipated to be adversely affected by a full-year’s impact of Reg E, lower interchange fees, and a decline in mortgage banking revenues.

Though the company’s cross-selling initiatives and other strategic efforts are expected to support other fee income categories, costs related to continued investments in business growth would represent challenges to earnings.

Huntington currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating. Moreover, Huntington’s peer – Northern Trust Corporation (NTRS) also retains a Zacks#3 Rank (a short-term ‘Hold’ rating).

 
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