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, 2003
Commission File Number: 000-33243
HUNTINGTON PREFERRED CAPITAL, INC.
OHIO 31-1356967
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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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.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
As of April 30, 2003, 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 I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
March 31, 2003 and 2002, and December 31, 2002 3
Consolidated Statements of Income -
For the three months ended March 31, 2003 and 2002 4
Consolidated Statements of Changes in Shareholders' Equity -
For the three months ended March 31, 2003 and 2002 5
Consolidated Statements of Cash Flows -
For the three months ended March 31, 2003 and 2002 6
Notes to Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
Item 4. Controls and Procedures 19
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
Certifications 23 - 24
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PART I. FINANCIAL INFORMATION
FINANCIAL STATEMENTS
HUNTINGTON PREFERRED CAPITAL, INC.
CONSOLIDATED BALANCE SHEETS
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MARCH 31, DECEMBER 31, MARCH 31,
(in thousands of dollars, except share data) 2003 2002 2002
------------------------------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
ASSETS
Cash and due from The Huntington National Bank $ 28,249 $ 534,254 $ 38,287
Interest bearing deposits with The Huntington National Bank 668,594 --- 653,245
Due from Huntington Preferred Capital Holdings, Inc. and The
Huntington National Bank 10,334 7,440 71,107
Loan participation interests
Commercial 284,225 344,858 557,975
Commercial real estate 3,951,895 3,922,467 3,831,498
Consumer 575,545 612,357 723,278
Residential real estate 132,123 153,808 229,228
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4,943,788 5,033,490 5,341,979
Less allowance for loan losses 125,884 140,353 171,007
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Net loan participation interests 4,817,904 4,893,137 5,170,972
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Premises and equipment 36,363 38,088 42,782
Accrued income and other assets 21,614 44,102 43,538
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TOTAL ASSETS $ 5,583,058 $ 5,517,021 $ 6,019,931
========================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Dividends payable and other liabilities $ 2,068 $ 670 $ 5,898
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Total Liabilities 2,068 670 5,898
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SHAREHOLDERS' EQUITY
Preferred stock, 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 stock, 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 stock, 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 stock, Class D, variable-rate noncumulative and
conditionally exchangeable; $25 par and liquidation
value; 14,000,000 shares authorized, issued, and outstanding 350,000 350,000 350,000
Preferred stock, $25 par value, 10,000,000 shares
authorized; no shares issued or outstanding --- --- ---
Common stock - without par value; 14,000,000 shares authorized,
issued and outstanding 4,715,351 4,715,351 5,082,511
Retained earnings 64,639 --- 130,522
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Total Shareholders' Equity 5,580,990 5,516,351 6,014,033
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 5,583,058 $ 5,517,021 $ 6,019,931
========================================================================================================================
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See notes to unaudited consolidated financial statements.
HUNTINGTON PREFERRED CAPITAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED
MARCH 31,
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(in thousands of dollars) 2003 2002
-------------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
Interest and fee income
Interest on loan participation interests
Commercial $ 3,955 $ 7,309
Commercial real estate 46,957 53,880
Consumer 13,379 20,044
Residential real estate 2,251 4,560
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66,542 85,793
Fees from loan participation interests 2,733 2,441
Interest bearing deposits with The Huntington
National Bank 1,854 1,878
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TOTAL INTEREST AND FEE INCOME 71,129 90,112
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Provision for loan losses --- 16,839
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NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 71,129 73,273
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Non-interest income
Rental income 1,806 1,535
Collateral fees 160 ---
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TOTAL NON-INTEREST INCOME 1,966 1,535
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Non-interest expense
Servicing fees 1,575 1,729
Depreciation and amortization 1,401 1,452
Other 382 458
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TOTAL NON-INTEREST EXPENSE 3,358 3,639
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INCOME BEFORE INCOME TAXES 69,737 71,169
Income taxes 24 (117)
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NET INCOME BEFORE PREFERRED DIVIDENDS 69,713 71,286
DIVIDENDS ON PREFERRED STOCK 5,074 5,981
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NET INCOME APPLICABLE TO COMMON SHARES $ 64,639 $ 65,305
=================================================================================================
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See notes to unaudited consolidated financial statements.
HUNTINGTON PREFERRED CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
PREFERRED, CLASS A PREFERRED, CLASS B PREFERRED, CLASS C
------------------ ------------------- ------------------
(in thousands) SHARES STOCK SHARES STOCK SHARES STOCK
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Three Months Ended March 31, 2002:
Balance, beginning of period 1 $ 1,000 400 $ 400,000 2,000 $ 50,000
Comprehensive Income:
Net income
Total comprehensive income
Dividends declared on Class A preferred stock
Dividends declared on Class B preferred stock
Dividends declared on Class C preferred stock
Dividends declared on Class D preferred stock
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Balance, end of period (Unaudited) 1 $ 1,000 400 $ 400,000 2,000 $ 50,000
==========================================================================================================
THREE MONTHS ENDED MARCH 31, 2003:
BALANCE, BEGINNING OF PERIOD 1 $ 1,000 400 $ 400,000 2,000 $ 50,000
COMPREHENSIVE INCOME:
NET INCOME
TOTAL COMPREHENSIVE INCOME
DIVIDENDS DECLARED ON CLASS A PREFERRED STOCK
DIVIDENDS DECLARED ON CLASS B PREFERRED STOCK
DIVIDENDS DECLARED ON CLASS C PREFERRED STOCK
DIVIDENDS DECLARED ON CLASS D PREFERRED STOCK
----------------------------------------------------------------------------------------------------------
BALANCE, END OF PERIOD (UNAUDITED) 1 $ 1,000 400 $ 400,000 2,000 $ 50,000
==========================================================================================================
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PREFERRED, CLASS D PREFERRED COMMON
------------------ ------------------ -------------------- RETAINED
(in thousands) SHARES STOCK SHARES STOCK SHARES STOCK EARNINGS TOTAL
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Three Months Ended March 31, 2002:
Balance, beginning of period 14,000 $350,000 --- $ --- 14,000 $ 5,082,511 $ 65,217 $ 5,948,728
Comprehensive Income:
Net income 71,286 71,286
-----------
Total comprehensive income 71,286
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Dividends declared on Class A preferred stock (80) (80)
Dividends declared on Class B preferred stock (1,864) (1,864)
Dividends declared on Class C preferred stock (985) (985)
Dividends declared on Class D preferred stock (3,052) (3,052)
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Balance, end of period (Unaudited) 14,000 $350,000 --- $ --- 14,000 $ 5,082,511 $130,522 $ 6,014,033
===================================================================================================================================
THREE MONTHS ENDED MARCH 31, 2003:
BALANCE, BEGINNING OF PERIOD 14,000 $350,000 --- $ --- 14,000 $ 4,715,351 $ --- $ 5,516,351
COMPREHENSIVE INCOME:
NET INCOME 69,713 69,713
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TOTAL COMPREHENSIVE INCOME 69,713
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DIVIDENDS DECLARED ON CLASS A PREFERRED STOCK (80) (80)
DIVIDENDS DECLARED ON CLASS B PREFERRED STOCK (1,380) (1,380)
DIVIDENDS DECLARED ON CLASS C PREFERRED STOCK (985) (985)
DIVIDENDS DECLARED ON CLASS D PREFERRED STOCK (2,629) (2,629)
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BALANCE, END OF PERIOD (UNAUDITED) 14,000 $350,000 --- $ --- 14,000 $ 4,715,351 $ 64,639 $ 5,580,990
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See notes to unaudited consolidated financial statements.
HUNTINGTON PREFERRED CAPITAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
MARCH 31,
----------------------------
(in thousands of dollars) 2003 2002
----------------------------------------------------------------------------------------------
(Unaudited) (Unaudited)
OPERATING ACTIVITIES
Net Income before preferred dividends $ 69,713 $ 71,286
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses --- 16,839
Depreciation and amortization 1,401 1,452
Loss on disposal of fixed assets 324 ---
Decrease (increase) in accrued interest and other assets 13,357 (255)
(Increase) decrease in due from/to Huntington
Preferred Capital Holdings, Inc. and The
Huntington National Bank (2,894) 222,702
Increase in accounts payable and other
liabilities (62) (114)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 81,839 311,910
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INVESTING ACTIVITIES
Participation interests acquired (1,342,367) (954,427)
Sales and repayments on loans underlying
participation interests 1,426,731 968,730
Proceeds from the sale of fixed assets --- 407
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NET CASH PROVIDED BY INVESTING ACTIVITIES 84,364 14,710
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FINANCING ACTIVITIES
Dividends paid on preferred stock (3,614) ---
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NET CASH USED FOR FINANCING ACTIVITIES (3,614) ---
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CHANGE IN CASH AND CASH EQUIVALENTS 162,589 326,620
CASH AND CASH EQUIVALENTS:
AT BEGINNING OF PERIOD 534,254 364,912
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AT END OF PERIOD $ 696,843 $ 691,532
==============================================================================================
Supplemental information:
Income taxes paid $ --- $ ---
Interest paid --- ---
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See notes to unaudited consolidated financial statements.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1 - ORGANIZATION
Huntington Preferred Capital, Inc. (HPCI) was organized under Ohio law in 1992 and designated as a real estate investment trust (REIT) in 1998. HPCI's common stock is owned by three related parties, HPC Holdings-III, Inc. (HPCH-III), a Nevada corporation, Huntington Preferred Capital II, Inc. (HPCII), also a REIT and an Ohio corporation, and Huntington Bancshares Incorporated (Huntington), a Maryland corporation headquartered in Columbus, Ohio. HPCI and HPCII are subsidiaries of HPCH-III, which is a subsidiary of Huntington Preferred Capital Holdings, Inc. (Holdings), an Indiana corporation. Holdings is a subsidiary of The Huntington National Bank (the Bank), a national banking association organized under the laws of the United States and also headquartered in Columbus, Ohio. The Bank is a wholly owned subsidiary of Huntington. HPCI has one subsidiary, HPCLI, Inc. (HPCLI), a taxable REIT subsidiary formed in March 2001 for the purpose of holding certain assets (primarily leasehold improvements).
2 - BASIS OF PRESENTATION
The unaudited interim consolidated financial statements reflect all adjustments, consisting of normal and/or recurring accruals, which are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, results of operations, and cash flows for the periods presented. These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). As permitted by the Securities and Exchange Commission, certain information and footnote disclosures normally included in financial statements have been omitted. The Notes to the Consolidated Financial Statements appearing in HPCI's 2002 Annual Report on Form 10-K (2002 Annual Report), which include descriptions of significant accounting policies, should be read in conjunction with these interim financial statements.
In preparing financial statements in conformity with GAAP, management of HPCI is required to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenue and expenses during the reporting period. An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements of HPCI if a different amount within a range of estimates were used or if estimates changed from period to period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to significant change relates to the determination of the allowance for loan losses.
Cash and cash equivalents used in the Statement of Cash Flows are defined as the sum of "Cash and due from The Huntington National Bank" and "Interest bearing deposits with The Huntington National Bank".
All of HPCI's common stock is owned by Huntington, HPCII, and HPCH-III and, therefore, earnings per common share information is not presented.
3 - LOAN PARTICIPATION INTERESTS
Participation interests are categorized based on the collateral securing the underlying loan. At March 31, loan participation interests were comprised of the following:
----------------------------------------------------------- (in thousands of dollars) 2003 2002 ----------------------------------------------------------- Commercial $ 284,225 $ 557,975 Commercial real estate 3,951,895 3,831,498 Consumer 575,545 723,278 Residential real estate 132,123 229,228 ----------------------------------------------------------- TOTAL LOAN PARTICIPATIONS $ 4,943,788 $ 5,341,979 =========================================================== |
There are no underlying loans outstanding which would be considered a concentration of lending in any particular industry, group of industries, or business activity. Underlying loans are, however, generally secured by real estate and concentrated to borrowers in the four states of Ohio, Michigan, Indiana, and Kentucky, which comprise 96.1% of the portfolio at March 31, 2003.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
PARTICIPATIONS IN NON-PERFORMING LOANS AND PAST DUE LOANS
At March 31, 2003 and 2002, the participations in loans in non-accrual status and loans past due 90 days or more and still accruing interest, were as follows:
------------------------------------------------------------------------------------------- (in thousands of dollars) 2003 2002 ------------------------------------------------------------------------------------------- Commercial $ 33,367 $ 126,724 Commercial real estate 27,041 42,737 Consumer --- --- Residential real estate 5,499 8,458 ------------------------------------------------------------------------------------------- TOTAL PARTICIPATIONS IN NON-ACCRUAL LOANS $ 65,907 $ 177,919 =========================================================================================== PARTICIPATIONS IN ACCRUING LOANS PAST DUE 90 DAYS OR MORE $ 15,575 $ 28,337 =========================================================================================== |
4 - ALLOWANCE FOR LOAN LOSSES
A summary of the transactions in the allowance for loan losses (ALL) follows for each of the quarters ended March 31:
--------------------------------------------------------------------------- (in thousands of dollars) 2003 2002 --------------------------------------------------------------------------- BALANCE, BEGINNING OF YEAR $ 140,353 $ 175,690 Allowance of loan participations acquired 11,657 6,561 Net loan losses (26,126) (28,083) Provision for loan losses --- 16,839 --------------------------------------------------------------------------- BALANCE, END OF YEAR $ 125,884 $ 171,007 =========================================================================== |
During the first quarter of 2003, a total of $12.2 million of interest receivables was determined to be uncollectible and charged off against the allowance for loan losses. These interest receivables related to loans that were previously charged off.
5 - DIVIDENDS
Holders of Class A preferred securities are entitled to receive, if, when, and as declared by the Board of Directors of HPCI out of funds legally available, dividends at a fixed rate of $80.00 per share per annum of the initial liquidation preference ($1,000.00 per share). Dividends on the Class A preferred securities, if declared, are payable annually in December to holders of record on the record date fixed for such purpose by the Board of Directors in advance of payment. Dividends of $80,000 for 2003 were declared and have been set aside for payment in December 2003 to the holders of record on November 30, 2003.
The holder of the Class B preferred securities, HPC Holdings-II, Inc., a direct non-bank subsidiary of Huntington, is entitled to receive, if, when, and as declared by the Board of Directors of HPCI out of funds legally available, dividends at a variable rate equal to the three-month LIBOR published on the first day of each calendar quarter. Dividends on the Class B preferred securities, which are declared quarterly, are payable annually and are non-cumulative. No dividend, except payable in common shares, may be declared or paid upon Class B preferred securities unless dividend obligations are satisfied on the Class A, Class C, and Class D preferred securities. Quarterly dividends of $1.4 million, based on a LIBOR rate of 1.38%, were declared in the first quarter 2003, compared with dividends declared of $1.9 million for the same period in 2002.
Holders of Class C preferred securities are entitled to receive, if, when, and as declared by the Board of Directors of HPCI out of funds legally available, dividends at a fixed rate of 7.875% per annum, payable quarterly. Dividends accrue in each quarterly period from the first day of each period, whether or not dividends are paid with respect to the preceding period. Dividends are not cumulative and if no dividend is paid on the Class C preferred securities for a quarterly dividend period, the payment of dividends on HPCI's common stock and other HPCI-issued securities ranking junior to the Class C preferred securities (i.e., Class B preferred securities) will be prohibited for that period and at least
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
the following three quarterly dividend periods. Dividends declared to the holders of the Class C preferred securities totaled $984,375, or $0.4921875 per share, in the first quarter of 2003 and 2002. Dividends were paid on March 31, 2003 and April 1, 2002, respectively.
The holder of Class D preferred securities, HPCH-III (Holdings, prior to December 27, 2002), is entitled to receive, if, when, and as declared by the Board of Directors of HPCI out of funds legally available, dividends at a variable rate established at the beginning of each calendar quarter equal to LIBOR plus 1.625%, payable quarterly. Dividends accrue in each quarterly period from the first day of each period, whether or not dividends are paid with respect to the preceding period. Dividends are not cumulative and if no dividend is paid on the Class D preferred securities for a quarterly dividend period, the payment of dividends on HPCI's common stock and other HPCI-issued securities ranking junior to the Class D preferred securities (i.e., Class B preferred securities) will be prohibited for that period and at least the following three quarterly dividend periods. Dividends declared to the holder of the Class D preferred securities totaled $2.6 million and $3.1 million in the first quarter of 2003 and 2002, respectively. Dividends were paid on March 31, 2003 and April 1, 2002, respectively.
6 - RELATED PARTY TRANSACTIONS
HPCI holds a 100% subparticipation interest in Holdings' 99% participation interests in loans originated by the Bank and its subsidiaries. The participation and subparticipation interests are in commercial, commercial real estate, residential real estate, and consumer loans that were either directly underwritten by the Bank and its subsidiaries or acquired by the Bank. Participation interests in loans are acquired from the Bank through Holdings by HPCI at the Bank's carrying value, which is the principal amount outstanding plus accrued interest, net of unearned income, if any, less an ALL. HPCI expects to continue to purchase such interests, net of ALL, in the future from Holdings, the Bank, or their affiliates.
Under HPCI's subparticipation agreement with Holdings and Holding's participation agreement with the Bank, the Bank performs the servicing of the commercial, commercial real estate, residential real estate, and consumer loans underlying the participations held by HPCI in accordance with normal industry practice. The servicing fee the Bank charges is 0.125% per year of the outstanding principal balances of the commercial, commercial real estate, and consumer loans underlying the participation interests and 2.35% of the interest income collected on the underlying residential real estate loans. Servicing fee expense paid to the Bank totaled $1.6 million for the three months ended March 31, 2003 and $1.7 million for the same period a year ago. In its capacity as servicer, the Bank collects and holds the loan payments received on behalf of HPCI until the end of each month. At month end, the payments are transferred to HPCI and, accordingly, HPCI does not reflect any receivables for payments from the Bank in the accompanying consolidated financial statements.
HPCI, Huntington, and the Bank share personnel to handle day-to-day operations of the company such as accounting, financial analysis, tax reporting, and other administrative functions. On a monthly basis, HPCI reimburses the Bank and Huntington for the cost related to the time spent by employees for performing these functions. The personnel costs were $40,000 for each of the three month periods ended March 31, 2003 and 2002.
In February 2001, Huntington purchased 18,667 shares of the 14 million outstanding common shares of HPCI from Holdings (after adjusting for the April 2001 18,666.67-for-1 stock split). Prior to February 2001, Holdings was the owner of 100% of the outstanding common stock of HPCI. On July 1, 2002, Holdings exchanged 4.55 million common shares of HPCI and certain other assets for two classes of HPCII's preferred stock. On December 27, 2002, Holdings contributed its ownership in HPCI's Class A and Class D preferred securities and its remaining common stock to HPCH-III. The following table represents the current ownership of HPCI's common and preferred stock:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
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Number of Number of Preferred Securities
Common ------------------------------------------------------
Owner at March 31, 2003: Shares Class A Class B Class C Class D
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Holdings --- --- --- --- ---
HPCH-III 9,431,333 892 --- --- 14,000,000
HPCII 4,550,000 --- 400,000 --- ---
Huntington 18,667 --- --- --- ---
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Total held by related parties 14,000,000 892 400,000 --- 14,000,000
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Other shareholders --- 108 --- 2,000,000 ---
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At March 31, 2003, 10.8% of the Class A preferred securities are owned by current and past employees of Huntington and its subsidiaries in addition to the 89.2% owned by HPCH-III. 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 purchased a portion of the Class C preferred securities in the open market. At December 31, 2002, a total of 7,100 shares, or 0.355%, were beneficially owned by HPCI board members and executive officers in the aggregate. All of the Class D preferred securities owned by HPCH-III are being held for possible sale to the public in the future. Dividends paid to the Class C and D shareholders in the first quarter of 2003 were $984,375 and $2,629,375, respectively.
Both the Class C and D preferred securities are entitled to one-tenth of one vote per share on all matters submitted to HPCI shareholders. The Class C and D preferred securities are exchangeable, without shareholder approval or any action of shareholders, for preferred securities of the Bank with substantially equivalent terms as to dividends, liquidation preference, and redemption if the Office of the Comptroller of the Currency (OCC) so directs only under the following circumstances where the Bank becomes or may in the near term become undercapitalized, or the Bank is placed in conservatorship or receivership. The Class C and Class D preferred securities are redeemable at HPCI's option on or after December 31, 2021, and December 31, 2006, respectively, with prior consent of the OCC.
HPCI's premises and equipment were acquired from the Bank through Holdings. Leasehold improvements were subsequently contributed to HPCLI for its common shares in the fourth quarter of 2001. HPCLI charges rent to the Bank for use of applicable facilities by the Bank. The amount of rental income received by HPCLI during the quarter ended March 31, 2003 and 2002 was $1.8 million and $1.5 million, respectively, and is reflected as a component of non-interest income in the consolidated statements of income.
HPCI has a non-interest bearing receivable from Holdings of $10.3 million at March 31, 2003, and $7.4 million at March 31, 2002. These balances represent unsettled cash transactions involving its participation interests that occur in the ordinary course of business.
The Bank is eligible to obtain advances from various federal and government-sponsored agencies such as the Federal Home Loan Bank of Cincinnati. 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. See Note 7 for further information regarding the pledging of HPCI's assets in association with the Bank's advances.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
HPCI maintains and transacts all of its cash activity through a non-interest bearing demand deposit account with the Bank. In addition, to the extent that it does not jeopardize qualification as a REIT, HPCI invests available funds in Eurodollar deposits with the Bank for a term of not more than 30 days. The following amounts were on deposit with the Bank at March 31:
------------------------------------------------------------- (in thousands of dollars) 2003 2002 ------------------------------------------------------------- Non-interest bearing $ 28,249 $ 38,287 Interest bearing 668,594 653,245 ------------------------------------------------------------- Total deposits with the Bank $ 696,843 $ 691,532 ============================================================= |
7 - COMMITMENTS AND CONTINGENCIES
The Bank is eligible to obtain advances from various federal and government-sponsored agencies such as the Federal Home Loan Bank of Cincinnati (FHLBC). 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 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 federal or government-sponsored agencies 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.
The Bank is currently eligible to obtain one or more advances from the FHLBC based upon the amount of FHLBC capital stock owned by the Bank. As of March 31, 2003, the Bank's total borrowing capacity under this facility was capped at $1.3 billion. As of this same date, the Bank had borrowings of $1.2 billion under this facility in addition to a standby letter of credit that was issued and outstanding in the amount of $1.8 million.
HPCI has entered into an agreement with the Bank with respect to the pledge of HPCI's assets to collateralize the Bank's borrowings from the FHLBC. The agreement provides that the Bank will not place at risk HPCI's assets in excess of an aggregate amount or percentage of such assets established from time to time by HPCI's board of directors, including a majority of HPCI's independent directors. HPCI's board has set this limit at $1 billion, which limit may be changed in the future by the board of directors, including a majority of HPCI's independent directors. The agreement also provides that the Bank will pay HPCI a monthly fee based upon the pledged collateral held by HPCI. As of March 31, 2003, HPCI's pledged collateral was limited to 1-4 family residential mortgages and second mortgage loans. As of that same date, HPCI's participation interests in 1-4 family residential mortgages and second mortgage loans pledged as collateral aggregated $494 million, which represented 80% of its eligible collateral. The Bank paid $160,000 to HPCI in the first quarter of 2003, representing twelve basis points per year on the collateral pledged, as compensation for making such assets available to the Bank as collateral. No fees were received in the first three months of 2002.
8 - 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.
ITEM 2. MANAGEMENTS'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
Huntington Preferred Capital, Inc. (HPCI) is an Ohio corporation operating as a Real Estate Investment Trust (REIT) for federal income tax purposes. 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.
HPCI is a subsidiary of HPC Holdings-III, Inc. (HPCH-III), which is a subsidiary of Huntington Preferred Capital Holdings, Inc. (Holdings). Holdings is owned by The Huntington National Bank (the Bank) and Huntington Bancshares Incorporated (Huntington). All of HPCI's day-to-day activities and the servicing of the loans underlying its participation interests are administered by the Bank. HPCI has one wholly-owned subsidiary, HPCLI, Inc. (HPCLI).
A participation agreement between the Bank and Holdings and a subparticipation agreement between Holdings and HPCI require the Bank to service HPCI's loan portfolio in a manner substantially the same as for similar work performed by the Bank for transactions on its own behalf. HPCI, however, has retained the right to elect to foreclose on mortgaged properties and the Bank has agreed to follow any such direction from HPCI in this regard. The Bank also collects and remits principal and interest payments, maintains perfected collateral positions, and submits and pursues insurance claims. In addition, the Bank provides to HPCI accounting and reporting services as required. The Bank is required to pay all expenses related to the performance of its duties under the participation and subparticipation agreements. These participation interests were all acquired from Holdings and Holdings acquired them from the Bank.
FORWARD-LOOKING STATEMENTS
Management's discussion and analysis of financial condition and results of operations contain forward-looking statements about HPCI, including descriptions of products or services, plans, or objectives of its management for future operations, and forecasts of its revenues, earnings, or other measures of economic performance. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts.
By their nature, forward-looking statements are subject to numerous assumptions, risks, and uncertainties. A number of factors, including, but not limited to, those set forth under the heading "Business Risks" included in Item 1 of HPCI's 2002 Annual Report on Form 10-K (2002 Annual Report) and other factors described from time to time in HPCI's other filings with the Securities and Exchange Commission, could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements.
Forward-looking statements speak only as of the date they are made. HPCI does not update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made or to reflect the occurrence of unanticipated events.
The following discussion and analysis, the purpose of which is to provide investors and others with information that HPCI's management believes to be necessary for an understanding of its financial condition, changes in financial condition, and results of operations, should be read in conjunction with the financial statements, notes, and other information contained in this document.
CRITICAL ACCOUNTING POLICIES
Note 1 to HPCI's consolidated financial statements included in its 2002
Annual Report lists significant accounting policies used in the development and
presentation of its financial statements. This discussion and analysis, 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 HPCI, its
financial position, results of operations, and cash flows.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requires HPCI's management to establish critical accounting policies and make accounting estimates, assumptions, and judgments that affect amounts recorded and reported in its financial statements. An accounting estimate requires assumptions about uncertain matters that could have a material effect on the financial statements of HPCI if a different amount within a range of estimates were used or if estimates changed from period
to period. Readers of this report should understand that estimates are made under facts and circumstances at a point in time and changes in those facts and circumstances could produce actual results that differ from when those estimates were made. A material estimate that is particularly susceptible to significant change relates to the determination of the allowance for loan losses.
OVERVIEW
HPCI's income is primarily derived from its participation interests in loans acquired from the Bank through Holdings. Income varies based on the level of these assets and interest rates earned on these assets. The cash flows from these assets are used to satisfy HPCI's preferred dividend obligations. The preferred stock is considered equity and therefore, the dividends are not reflected as interest expense.
HPCI's net income before preferred dividends was $69.7 million for the first three months of 2003 versus $71.3 million for the same period a year ago. Net income available to common shareholders was $64.6 million for the first quarter of 2003, compared with $65.3 million for the year-ago first quarter.
HPCI had total assets and total equity (including preferred stock) of $5.6 billion at March 31, 2003, down slightly from $6.0 billion a year earlier. At March 31, 2003 and 2002, an aggregate of $4.9 billion and $5.3 billion, respectively, consisted of 99% participation interests in loans. Participation interests in specific underlying loans were as follows:
---------------------------------------------------------------------------------------------------------------
AT MARCH 31,
---------------------------------------------------------------------------------------------------------------
% OF % OF
TOTAL TOTAL
(in thousands of dollars) 2003 ASSETS 2002 ASSETS
---------------------------------------------------------------------------------------------------------------
Gross loan participation interests:
Commercial $ 284,225 5.1 $ 557,975 9.3
Commercial real estate 3,951,895 70.6 3,831,498 63.6
Consumer 575,545 10.3 723,278 12.0
Residential real estate 132,123 2.4 229,228 3.8
---------------------------------------------------------------------------------------------------------------
Total $ 4,943,788 88.4 $ 5,341,979 88.7
===============================================================================================================
|
Participation interests in commercial loans and residential real estate loans declined 49% and 42%, respectively. HPCI has not acquired additional participation interests in these loans over the past several quarters. Participation interests in commercial real estate loans at March 31, 2003 increased 3% over levels at the end of the same period last year. At the beginning of 2003, HPCI began to invest only in commercial real estate loans that were fully collateralized by real estate. Participation interests in consumer loans decreased 20% for the same comparable periods as scheduled payment and prepayment activity in this portfolio outpaced the investment in new participation interests, which was comprised largely of interests in home equity loans secured by first and second mortgages.
Qualification as a REIT involves application of specific provisions of
the Internal Revenue Code relating to income and asset tests. A REIT must
satisfy six asset tests quarterly: (1) 75 percent 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 percent of the value of the REIT's
total assets may consist of securities, other than those includible under the 75
percent test; (3) not more than five percent of the value of its total assets
may consist of securities of any one issuer, other than those securities
includible under the 75 percent test or securities of taxable REIT subsidiaries;
(4) not more than 10 percent of the outstanding voting power of any one issuer
may be held, other than those securities includible under the 75 percent test or
securities of taxable REIT subsidiaries; (5) not more that 10 percent of the
total value of the outstanding securities of any one issuer may be held, other
than those securities includible under the 75 percent 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 percent of its total
assets. Also, a REIT must annually satisfy two gross income tests: (1) 75
percent of its gross income must be from qualifying income closely connected
with real estate activities; and (2) 95 percent of its gross income must be
derived from sources qualifying for the 75 percent test plus dividends, interest
and gains from the sale of securities. At March 31,2003, HPCI had qualifying
assets that exceeded 75 percent of the value of its total assets.
HPCI intends to operate in a manner that will not cause it 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, HPCI must invest at least 55 percent of its assets in Qualifying Interests and an additional 25 percent of its assets in real estate-related assets, although this percentage may be reduced to the extent that more than 55 percent of its assets are invested in Qualifying Interests. The assets in which HPCI may invest under the Internal Revenue Code therefore may be further limited by the provisions of the Investment Company Act and positions taken by the SEC staff. HPCI intends to operate its business in a manner that will maintain its exemption from registration as an investment company under the Investment Company Act.
Interest-bearing and non-interest bearing cash balances on deposit with the Bank were $696.8 million at March 31, 2003, up slightly from $691.5 million at March 31, 2002. Interest bearing balances are invested overnight or in Eurodollar deposits with the Bank for a term of not more than 30 days. Typically, cash is invested with the Bank in an interest bearing account. Interest-bearing and non-interest bearing cash balances on deposit with the Bank were $534.3 million at December 31, 2002.
At March 31, 2003, amounts due from Holdings and the Bank were $10.3 million, down from $71.1 million a year ago but up slightly from $7.4 million at the most recent year end. These represent amounts due from or due to Holdings and/or the Bank that arise in the ordinary course of business for unsettled transactions involving participation interests, fees, and other related costs. Dividends payable and other liabilities declined from $5.9 million at the end of the first quarter last year to $2.1 million at March 31, 2003. This decline was due to the timing of the payment of dividends paid on the Class C and D preferred securities.
Shareholders' equity (including preferred stock) was $5.6 billion at March 31, 2003, down from $6.0 billion at March 31, 2002. This decline largely reflected the impact of the declaration and payment of common and preferred dividends and return of capital on December 31, 2002.
RESULTS OF OPERATIONS
INTEREST AND FEE INCOME
HPCI's primary source of revenue is interest and fee income on its participation interests in loans. At March 31, 2003 and 2002, HPCI did not have any interest-bearing liabilities nor related interest expense. HPCI's capital structure has provided funding for acquisition of participation interests and the continued cash flows from its participation interests in loans provide sufficient funding such that outside borrowings are not required. Interest income is impacted by changes in the level of interest rates and earning assets. The yield on earning assets is the percentage of interest income to average earning assets.
For the three-month period ended March 31, HPCI's average balances, interest and fee income, and yields are presented below:
--------------------------------------------------------------------------------------------------------------
2003 2002
----------------------------------- ---------------------------------
AVERAGE AVERAGE
(in millions of dollars) BALANCE INCOME YIELD BALANCE INCOME YIELD
--------------------------------------------------------------------------------------------------------------
Loan participation interests:
Commercial $ 323.4 $ 3.9 4.96% $ 607.1 $ 7.3 4.88%
Commercial real estate 3,893.3 47.0 4.89 3,733.8 53.9 5.85
Consumer 599.8 13.4 9.05 763.3 20.0 10.65
Residential real estate 146.1 2.2 6.16 256.3 4.6 7.12
--------------------------------------------------------------------------------------------------------------
Total loan participations 4,962.6 66.5 5.44 5,360.5 85.8 6.49
--------------------------------------------------------------------------------------------------------------
Interest bearing deposits
in banks 617.6 1.9 1.22 423.0 1.9 1.80
Fees from loan participation
interests 2.7 2.4
--------------------------------------------------------------------------------------------------------------
Total $ 5,580.2 $ 71.1 5.17% $ 5,783.5 $ 90.1 6.31%
==============================================================================================================
|
Interest and fee income was $71.1 million for the first three months of 2003, compared with $90.1 million for the year ago quarter. Approximately 70% of the decline in interest and fee income was due to the lower interest rate environment and the remainder due to declines in average participation balances. Approximately three-quarters of
the loan participation portfolio is variable in nature with respect to interest rate. As shown in the table above, the yield on HPCI's participation interests declined from 6.49% to 5.44%. The table above includes interest received on participations in loans that are on a non-accrual status in the individual portfolios.
The table below shows changes in interest and fee income for the three month periods ended March 31 due to volume and rate variances for each category of earning assets. The change in interest and fees not solely due to changes in volume or rates has been allocated in proportion to the absolute dollar amounts of the change in volume and rate.
--------------------------------------------------------------------------------------------------------------------------
2003 2002
--------------------------------------------------------------------------------------------------------------------------
Increase (Decrease) From Increase (Decrease) From
Previous Year Due To: Previous Year Due To:
--------------------------------------------------------------------------------------------------------------------------
Yield/ Yield/
(in millions of dollars) Volume Rate Total Volume Rate Total
--------------------------------------------------------------------------------------------------------------------------
Interest bearing deposits in The
Huntington National Bank $ 0.7 $ (0.7) $ --- $ (4.6) $ (5.8) $ (10.4)
Loan participation interests:
Commercial (3.6) 0.1 (3.5) --- (4.6) (4.6)
Commercial real estate 2.3 (8.8) (6.5) (5.1) (22.7) (27.8)
Consumer (4.0) (2.6) (6.6) (5.9) 2.8 (3.1)
Residential real estate (1.8) (0.6) (2.4) (3.6) (1.1) (4.7)
--------------------------------------------------------------------------------------------------------------------------
TOTAL EARNING ASSETS (6.4) (12.6) (19.0) (19.2) (31.4) (50.6)
--------------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST-BEARING LIABILITIES --- --- --- --- --- ---
--------------------------------------------------------------------------------------------------------------------------
INTEREST AND FEE INCOME $(6.4) $(12.6) $(19.0) $(19.2) $ (31.4) $ (50.6)
==========================================================================================================================
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PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES (ALL)
The provision for loan losses is the charge to earnings necessary to maintain the ALL at a level adequate to absorb management's estimate of inherent losses in the loan portfolio. There was no provision for loan losses for the first quarter of 2003. This compared with an expense of $16.8 million for the same period last year. The decline in provision expense in 2003 from 2002 was indicative of the significantly lower level of non-performing loans underlying HPCI's participation interests and slightly lower losses on loan participations.
The ALL was $125.9 million at March 31, 2003, down from $140.4 million at December 31, 2002, and $171.0 million at March 31, 2002. This represents 2.55%, 2.79%, and 3.20% of total loan participations at the end of each respective period. The ALL decreased from March and December of last year because of the factors described above related to provision expense. The ALL covered 191.0% of the participations in non-performing loans at the end of March 2003, compared to 145.4% and 96.1% at December 31, 2002 and March 31, 2002, respectively. In management's judgment, the ALL is adequate at March 31, 2003 to cover losses inherent in the loan participation portfolio. Additional information regarding the ALL and asset quality appears in the "Credit Quality" section. The following table shows the activity in HPCI's ALL for each of the quarters ended March 31,:
----------------------------------------------------------------------------------------------------------------
(in thousands of dollars) 2003 2002
----------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF PERIOD $ 140,353 $ 175,690
Allowance of loan participations acquired, net 11,657 6,561
Net loan losses
Commercial (8,582) (14,203)
Commercial real estate (960) (6,009)
Consumer (14,534) (7,871)
Residential real estate (2,050) ---
----------------------------------------------------------------------------------------------------------------
Total net loan losses (26,126) (28,083)
----------------------------------------------------------------------------------------------------------------
Provision for loan losses --- 16,839
----------------------------------------------------------------------------------------------------------------
BALANCE, END OF PERIOD $ 125,884 $ 171,007
================================================================================================================
|
Total net charge-offs for the quarter ended March 31, 2003, were $26.1 million, or 2.11% (annualized) of average participation interests, slightly lower than the $28.1 million, or 2.10%, recorded in the same quarterly period one year ago but up significantly from $12.9 million, or 0.99%, for the last quarter of 2002. During the first quarter of 2003, a total of $12.2 million of interest receivables was determined to be uncollectible and charged off against the allowance for loan losses. These interest receivables related to loans that were previously charged off.
It is HPCI's policy to perform a detailed analysis as of the end of each period to estimate the level of the ALL. HPCI, through reliance on methods utilized by Huntington, allocates the ALL to each loan participation category. For the commercial and commercial real estate loan participations, expected loss factors are assigned by credit grade at the individual underlying loan level at the time the loan is originated by the Bank. On a periodic basis, management reevaluates these credit grades. The aggregation of these factors represents management's estimate of the inherent loss. The portion of the allowance allocated to the more homogeneous underlying consumer and residential real estate loan participations is determined by developing expected loss ratios based on the risk characteristics of the various portfolio segments and giving consideration to existing economic conditions and trends.
Expected loss ratios also incorporate factors such as trends in past due and non-accrual amounts, recent underlying loan loss experience, current economic conditions, risk characteristics, and concentrations of various underlying loan categories. Actual loss ratios experienced in the future could vary from those expected, as performance is a function of factors unique to each customer as well as general economic conditions. To ensure adequacy of the total ALL, it includes a general unallocated component. Management believes that an unallocated reserve of 15% of the total allowance for loan losses at March 31, 2003 is appropriate given (1) the composition of the loans underlying HPCI's participation interests, predominantly commercial real estate, commercial loans, and lower quality consumer loans; and (2) the increase in uncertainties in the general economic outlook and world events that could impact customers' ability to make payments. Management will continue to monitor the need for an unallocated reserve of this magnitude on a quarterly basis. While amounts are allocated to various portfolio segments, the total ALL, excluding impairment reserves prescribed under provisions of Statement of Financial Accounting Standard No. 114, is available to absorb losses from any segment of the loan participation portfolio.
NON-INTEREST INCOME AND NON-INTEREST EXPENSE
Non-interest income was $2.0 million for the first quarter of 2003 compared with $1.5 million for the comparable quarter a year ago. This largely represents rental income received from the Bank related to land, buildings, and leasehold improvements owned by HPCI. In addition, non-interest income includes fees from the Bank for use of its assets as collateral for the Bank's advances from the Federal Home Loan Bank of Cincinnati (FHLBC). These fees totaled $160,000 for the first quarter of 2003. HPCI began receiving these fees after the first quarter of last year. See Note 7 to the unaudited consolidated financial statements for more information regarding use of HPCI's assets as collateral for the Bank's advances from the FHLBC.
Non-interest expense was $3.4 million for the recent three months versus $3.6 million for the first quarter of 2002. The predominant components of HPCI's non-interest expense are the fees paid to the Bank for servicing the loans underlying the participation interests and depreciation and amortization on its premises and equipment. Servicing fees amounted to $1.6 million for the first three months of 2003, down slightly from the $1.7 million recorded in the same period of 2002 due to a decline in average loan participations. On an annual basis, the service fee with respect to the commercial real estate, commercial, and consumer loans is equal to the outstanding principal balance of each loan multiplied by a fee of 0.125% and the service fee for residential real estate loans is equal to 2.35% of the interest income collected. Depreciation on premises and equipment was $1.4 million and $1.5 million for the first quarter of 2003 and 2002, respectively.
PROVISION FOR INCOME TAXES
HPCI has 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 income taxes. HPCI's subsidiary, HPCLI, elected to be treated as a taxable REIT subsidiary and, therefore, a separate provision related to its income taxes is included in the accompanying unaudited consolidated financial statements.
INTEREST RATE RISK MANAGEMENT
HPCI's income consists primarily of interest income on participation interests in commercial, consumer, residential real estate, and commercial real estate loans. If there is a decline in market interest rates, HPCI may experience a reduction in interest income on its participation interests and a corresponding decrease in funds available to be distributed to shareholders. The reduction in interest income may result from downward adjustments of the indices upon which the interest rates on underlying variable rate loans are based and from prepayments of underlying loans with fixed interest rates as well as reinvestment in lower-earning assets.
Huntington conducts its interest rate risk management on a centralized basis and does not manage HPCI's interest rate risk separately. A key element used in Huntington's interest rate risk management is an income simulation model, which includes, among other things, assumptions for loan prepayments on the existing portfolio and new loan volumes. Using that model for HPCI as of March 31, 2003, and assuming no new loan participation volumes, interest income for the next 12 month period would be expected to increase by 8.5% if rates rose 200 basis points gradually and with a parallel shift of the yield curve above the forward rates implied in the March 31, 2003 yield curve. Interest income would be expected to decline 7.3% in the event of a gradual 200 basis point decline in rates from the forward rates implied in the March yield curve.
CREDIT QUALITY
HPCI's exposure to credit risk is managed by personnel of the Bank through its use of consistent underwriting standards that emphasize "in-market" lending while avoiding highly leveraged transactions as well as excessive industry and other concentrations. The Bank's credit administration function employs risk management techniques to ensure that loans adhere to corporate policy and problem loans are promptly identified. These procedures provide executive management of the Bank and HPCI with the information necessary to implement policy adjustments where necessary, and to take corrective actions on a proactive basis. These procedures also include evaluating the adequacy of the ALL, which includes an analysis of specific credits and the application of relevant reserve factors that represent relative risk, based on portfolio trends, current and historic loss experience, and prevailing economic conditions, to specific portfolio segments. In 2002, the Bank initiated a company-wide project to revise its internal risk grading system for commercial and commercial real estate credits. The Bank migrated from a single grading to a dual risk grading system that measures the probability of default and loss in event of default separately. The new dual risk grading system allows the Bank to be significantly more specific in the risk assessment process. This dual grading process is an industry standard and management believes that this change positions the Bank to continue the focus on improving credit quality.
Concentration of credit risk generally arises with respect to participation interests when a number of underlying loans have borrowers engaged in similar business activities or activities in the same geographical region. Concentration of credit risk indicates the relative sensitivity of performance to both positive and negative developments affecting a particular industry. Borrowers obligated in loans underlying HPCI's participation interests, however, do not represent a particular concentration of similar business activity. HPCI's balance sheet exposure to geographic concentrations directly affects the credit risk of the underlying loans within the participation interests. The majority of the loans underlying the participation interests are located in Ohio, Michigan, Indiana, and Kentucky. At March 31, 2003, 96.1% of the underlying loans in all participation interests consisted of loans located in these four states. Consequently, the portfolio may experience a higher default rate in the event of adverse economic, political, or business developments or natural hazards in these states and may affect the ability of borrowers to make payments of principal and interest on the underlying loans.
A participation interest acquired by HPCI in an underlying loan is considered impaired when, based on current information and events, it is determined that estimated cash flows are less than the cash flows estimated at the date of purchase. An underlying loan originated by the Bank is considered impaired when, based on current information and events, it is probable that it will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower. This includes the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Loan impairment is measured on a loan-by-loan basis by comparing the recorded investment in the loan to the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Non-performing assets (NPAs) consist of participation interests in underlying loans that are no longer accruing interest. Underlying commercial and commercial real estate loans are placed on non-accrual status and stop accruing interest when collection of principal or interest is in doubt or generally when the underlying loan is 90 days past due. Underlying residential real estate loans are generally placed on non-accrual status within 180 days past due as to principal and 210 days past due as to interest. 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.
Consumer loans are not placed on non-accrual status; rather they are charged off in accordance with regulatory statutes governing the Bank, which is generally no more than 120 days.
---------------------------------------------------------------------------------------------------
NON-PERFORMING ASSETS AT MARCH 31,
---------------------------------------------------------------------------------------------------
(in thousands of dollars) 2003 2002
---------------------------------------------------------------------------------------------------
Participation interests in non-accrual loans
Commercial $ 33,367 $ 126,724
Real Estate
Commercial 27,041 42,737
Residential 5,499 8,458
---------------------------------------------------------------------------------------------------
Total Non-Performing Assets $ 65,907 $ 177,919
===================================================================================================
NON-PERFORMING ASSETS AS A % OF TOTAL
PARTICIPATION INTERESTS 1.33% 3.33%
ALLOWANCE FOR LOAN LOSSES AS A % OF NON-
PERFORMING ASSETS 191.0% 96.1%
|
Total NPAs were $65.9 million, down from $96.5 million at December 31, 2002, and $177.9 million at March 31, 2002. As of the same dates, the underlying non-performing loans represented 1.33%, 1.92%, and 3.33% of total participation interests. There was an improvement in the level of participation interests in non-performing loans during the recent three months. The change in non-performing assets during the recent quarter included participation interests in underlying loans transferring to nonaccrual status of $36.2 million, offset by charge-offs of $10.4 million, sales of $3.0 million, payments received of $47.5 million, and returns to accruing status of $5.9 million.
Underlying loans past due ninety days or more but continuing to accrue interest also declined to $15.6 million at March 31, 2003, from $26.1 million at December 31, 2002, and $28.3 million at March 31, 2002.
Under the participation and subparticipation agreements, HPCI may direct the Bank to dispose of any underlying loan that becomes classified, is placed in a non-performing status, or is renegotiated due to the financial deterioration of the borrower. The Bank may institute foreclosure proceedings at the discretion of HPCI, 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 participation and subparticipation agreement. Any participation interest in a loan is sold to the Bank at fair market value where the security is either repossessed or goes into foreclosure proceedings. The Bank then incurs all costs associated with repossession and foreclosure.
LIQUIDITY AND CAPITAL RESOURCES
The objective of HPCI's liquidity management is to ensure the availability of sufficient cash flows to meet all of its financial commitments and to capitalize on opportunities for business expansion. In managing liquidity, management takes into account various legal limitations placed on a REIT.
HPCI's principal liquidity needs are to pay operating expenses and dividends and acquire additional participation interests as the underlying loans in its portfolio paydown or mature. Operating expenses and dividends are expected to be funded through cash generated by operations, while the acquisition of additional participation interests in loans is intended to be funded with the proceeds obtained from repayment of principal balances by individual borrowers and new capital contributions. HPCI intends to pay dividends on its preferred stock and common stock in amounts necessary to continue to preserve its status as a REIT under the Internal Revenue Code.
At March 31, 2003 and 2002, HPCI maintained interest bearing and non-interest bearing cash balances with the Bank totaling $696.8 million and $691.5 million, respectively. HPCI maintains and transacts all of its cash activity with the Bank and invests available funds in Eurodollar deposits with the Bank for a term of not more than 30 days.
To the extent that the board of directors determines that additional funding is required, management may raise such funds through additional equity offerings, debt financings, or retention of cash flow, or a combination of these methods. However, any cash flow retention must be consistent with the provisions of the Internal Revenue Code 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. Management does not anticipate that additional funding will be required for at least the next twelve months.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Quantitative and qualitative disclosures for the current period are found beginning on page 16 of this report, which includes changes in market risk exposures from disclosures presented in HPCI's 2002 Annual Report.
ITEM 4. CONTROLS AND PROCEDURES
On May 14, 2003, HPCI, in conjunction with Huntington, carried out an evaluation, under the supervision and with the participation of its management, including the President (Chief Executive Officer or CEO) along with the Vice President (Chief Financial Officer or CFO), of the effectiveness of the design and operation of its disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the CEO along with the CFO concluded that HPCI's disclosure controls and procedures are effective in timely alerting the CEO and CFO to material information relating to HPCI (including its consolidated subsidiary) required to be included in its periodic SEC filings.
There have been no significant changes in HPCI's internal controls or in other factors that could significantly affect its internal controls subsequent to the date it carried out this evaluation.
QUARTERLY STATEMENTS OF INCOME
2003 2002
--------- ----------------------------------------------------
(in thousands of dollars) FIRST FOURTH THIRD SECOND FIRST
------------------------------------------------------------------------------------------------------------------
Interest and fee income
Interest on loan participation interests
Commercial $ 3,955 $ 5,734 $ 5,421 $ 6,440 $ 7,309
Commercial real estate 46,957 50,951 53,512 54,290 53,880
Consumer 13,379 16,838 18,198 18,882 20,044
Residential real estate 2,251 2,807 3,403 3,851 4,560
------------------------------------------------------------------------------------------------------------------
66,542 76,330 80,534 83,463 85,793
------------------------------------------------------------------------------------------------------------------
Fees from loan participation interests 2,733 1,988 2,135 2,737 2,441
Interest bearing deposits in banks 1,854 3,138 4,033 3,284 1,878
------------------------------------------------------------------------------------------------------------------
TOTAL INTEREST AND FEE INCOME 71,129 81,456 86,702 89,484 90,112
------------------------------------------------------------------------------------------------------------------
Provision for loan losses --- (20,000) --- 3,000 16,839
------------------------------------------------------------------------------------------------------------------
NET INTEREST INCOME
AFTER PROVISION FOR LOAN LOSSES 71,129 101,456 86,702 86,484 73,273
------------------------------------------------------------------------------------------------------------------
Non-interest income
Rental income 1,806 1,520 1,530 1,533 1,535
Collateral fees 160 177 191 273 ---
------------------------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST INCOME 1,966 1,697 1,721 1,806 1,535
------------------------------------------------------------------------------------------------------------------
Non-interest expense
Servicing fees 1,575 1,647 1,623 1,715 1,729
Depreciation and amortization 1,401 1,437 1,428 1,450 1,452
Other 382 150 101 92 458
------------------------------------------------------------------------------------------------------------------
TOTAL NON-INTEREST EXPENSE 3,358 3,234 3,152 3,257 3,639
------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 69,737 99,919 85,271 85,033 71,169
Income taxes 24 25 22 25 (117)
------------------------------------------------------------------------------------------------------------------
NET INCOME BEFORE PREFERRED DIVIDENDS 69,713 99,894 85,249 85,008 71,286
DIVIDENDS ON PREFERRED STOCK 5,074 5,709 5,892 6,232 5,981
------------------------------------------------------------------------------------------------------------------
NET INCOME APPLICABLE TO
COMMON SHARES (1) $ 64,639 $ 94,185 $ 79,357 $ 78,776 $ 65,305
==================================================================================================================
|
(1) All of HPCI's common stock is owned by Huntington, HPCII, and HPCH-III and, therefore, earnings per common share information is not presented.
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 and Reports on Form 8-K
(a) Exhibits
10. Material contracts:
(a) Amended and Restated Loan
Participation Agreement between The
Huntington National Bank and
Huntington Preferred Capital
Holdings, Inc.
(b) Amended and Restated Loan
Subparticipation Agreement between
Huntington Preferred Capital
Holdings, Inc. and Huntington
Preferred Capital, Inc.
(c) Loan Subparticipation Agreement
between Huntington Preferred
Capital Holdings, Inc. and HPC
Holdings-III, Inc.
(d) Loan Subparticipation Agreement
between HPC Holdings-III, Inc. and
Huntington Preferred Capital, Inc.;
(e) Loan Participation Agreement
between The Huntington National
Bank and Huntington Preferred
Capital, Inc.;
99.1 Principal Executive Officer Certification
99.2 Principal Financial Officer Certification
|
(b) Reports on Form 8-K
None.
SIGNATURES
Pursuant to the requirements 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.
Huntington Preferred Capital, Inc.
(Registrant)
Date: May 15, 2003 /s/ Michael J. McMennamin
---------------------------
Michael J. McMennamin
President
(Principal Executive Officer)
Date: May 15, 2003 /s/ John D. Van Fleet
-----------------------------
John D. Van Fleet
Vice President
(Principal Financial Officer)
|
CERTIFICATION
I, Michael J. McMennamin, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Huntington Preferred Capital, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ Michael J. McMennamin
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Michael J. McMennamin, President
(chief executive officer)
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CERTIFICATION
I, John D. Van Fleet, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Huntington Preferred Capital, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize, and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: May 15, 2003
/s/ John D. Van Fleet
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John D. Van Fleet, Vice President
(chief financial officer)
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EXHIBIT 10 (a)
AMENDED AND RESTATED
LOAN PARTICIPATION AGREEMENT
This Amended and Restated Loan Participation Agreement (this "Agreement") is made and entered into as of May 12, 2003, between THE HUNTINGTON NATIONAL BANK ("Transferor") and HUNTINGTON PREFERRED CAPITAL HOLDINGS, INC., an Indiana corporation formerly known as Airbase Realty Holding Company ("Transferee").
RECITALS
A. The parties have previously entered into a certain Loan Participation Agreement, dated as of May 1, 1998, as the same has been amended by two Amendments to Loan Participation Agreement, dated March 1, 2001, and March 27, 2002, respectively (collectively, the "Original Agreement"), whereby Transferor has transferred and will continue to transfer to Transferee participation interests in certain loans (the "Loans") made by Transferor or an affiliate of Transferor to various borrowers (collectively, the "Borrowers"), as such Loans have been and may be identified from time to time by Transferor pursuant to Section 2 below, or substituted for other Loans previously transferred by Transferor to Transferee, pursuant to such Section 2.
B. The parties desire to amend further the Original Agreement and to restate the Original Agreement, incorporating all prior amendments thereto.
AGREEMENT
1. Definitions.
(a) "Loan Documents" shall mean any and all loan agreements evidencing or otherwise relating to any of the Loans, together with any and all commitment letters, promissory notes, real estate mortgages, assignments and security agreements, financing statements, pledge agreements, letters of credit, applications and agreements for standby letters of credit, letter of credit reimbursement agreements, subordination agreements, waivers, affidavits, fire and extended coverage insurance policies, guarantees, title insurance policies, applications, reports, surveys, documents required to be maintained by lenders pursuant to any applicable federal or state regulations, any and all amendments, modifications or supplements to any of the foregoing from time to time, and all other relevant documents pertaining to any of the Loans.
(b) "Collateral" shall mean the real property, fixtures, equipment, inventory, accounts, chattel paper, instruments, documents, general intangibles, securities and all other property and property rights in which Transferor has been granted a mortgage, lien or security interest in connection with any of the Loans.
(c) "Origination Fees" shall mean the origination, commitment, or other fees collected at the time of origination of a particular Loan.
(d) "Participation" and "Participation Interest" shall mean the interest of Transferee in the Loans and in the associated Origination Fees, equal to up to a one hundred percent (100%) interest in each of the Loans and associated Origination Fees.
(e) "Participation Share," "Pro Rata Share," "pro rata," and "ratably" shall mean a share in the same proportion as the respective percentage ownership interests of Transferor and Transferee in the Loans and associated Origination Fees.
2. Transfer of Participation Interests; Substitution of Interests.
(a) Transferee shall from time to time buy from Transferor or from an affiliate of Transferor, without recourse, a continuing undivided fractional Participation Interest, and Transferor shall from time to time sell to Transferee, or cause an affiliate or affiliates of Transferor to sell to Transferee, such Participation Interests. The purchase price for a particular Participation Interest transferred shall be Transferee's Participation Share of Transferor's carrying value for the Loan, which is the outstanding principal balance of the Loan and interest earned thereon but not collected, net of unearned income, if any, less an allowance for loan losses. Transfers of Participation Interests by Transferor or an affiliate of Transferor to Transferee hereunder may, upon the mutual agreement of the parties at the time any such transfers are made, be made (i) as additional contributions to the capital of Transferee, (ii) in exchange for the payment of cash by Transferee to Transferor or appropriate affiliate of Transferor, (iii) in consideration of the issuance to Transferor or appropriate affiliate of Transferor of shares of the capital stock of Transferee, or (iv) for such other consideration as the parties shall mutually agree.
(b) At the time of any transfer of a Participation Interest, Transferor will assign to Transferee, without recourse, Transferee's Participation Share of Transferor's beneficial right, title and interest in the Loans and associated Origination Fees, including any Collateral for the Loans, and any uncollected payments or collections on account of the Loans. Transferor shall hold title to the Loans, including any Collateral payments and collections as agent for Transferee.
(c) Upon the mutual agreement of the parties, Transferor may from time to time substitute a Participation Interest in a Loan or group of Loans and the associated Origination Fees (the "New Loans") having a fair market value (as determined by the mutual agreement of the parties) equivalent to the Participation Interest in a Loan or group of Loans and the associated Origination Fees previously transferred to Transferee hereunder (the "Old Loans"), whereupon the Participation Interest previously granted by Transferor to Transferee in the Old Loans will be canceled and Transferee shall have a Participation Interest in the New Loans. Such a substitution may be made as part of a purchase or other transfer of additional Participation Interests in accordance with paragraph (a) above. Any amounts payable by Transferor to Transferee hereunder on account of the Old Loans, prorated through the date of the substitution, shall be paid by Transferor to Transferee at the time of such substitution.
(d) Each of the Loans which shall be subject to this Agreement shall be (i) identified on a completed "Certificate of Participation" in the form of Exhibit A attached hereto,
which shall be delivered by Transferor to Transferee and shall contain at least the name of each Borrower, the date of the promissory note evidencing each Loan, the original principal amount of each Loan, the amount of any associated Origination Fees, and the purchase price associated with the same; or (ii) otherwise identified electronically or in the loan files for the Loans, in a manner that is mutually agreeable to Transferor and Transferee and sufficient to properly identify the Loans.
3. Representations and Warranties. At the time of transfer of Participation Interests to Transferee, Transferor represents and warrants that Transferor has good title to the Loans and has full right, power, and authority to grant and convey the Participation in the Loans provided for herein to Transferee, and, at the time of transfer of Participation Interests to Transferee, the Loans are free and clear of all encumbrances or other interests of any other person.
4. Transferee's Risk. Transferee acknowledges and agrees that Transferor has made no representation or warranty and has no responsibility as to: (i) the collectibility of the Loans; (ii) the Borrowers' creditworthiness or financial condition; (iii) the legality, validity, binding effect or enforceability of the Loan Documents; (iv) the filing, recording or taking of any other action with respect to the Loan Documents; (v) any other matter having any relation to the Loans, the Loan Documents, this Agreement, the Borrowers, or any other person or entity except as otherwise specifically set forth herein. Transferee acknowledges that Transferor has made available to it copies of the Loan Documents requested by Transferee. Transferee acknowledges and agrees that it has made its own independent investigation and determination with respect to the foregoing matters and accepts full responsibility therefor. The sale of the Participation Interests by Transferor to Transferee pursuant to this Agreement shall be and is without recourse of any nature.
5. Custody and Ownership of Loan Documents and Collateral. Transferor shall have and maintain physical possession of all the Loan Documents and Collateral, to the extent that possession is necessary to perfect a security interest in any Collateral. Transferor shall use reasonable care to safeguard and protect the Loan Documents and Collateral. Transferor is authorized to deal with the Loans in Transferor's own name, subject to the terms and conditions of this Agreement, and, as far as third parties are concerned, to act on behalf of Transferee as though Transferor were the sole owner of the Loans; provided, however, that all of Transferor's actions with respect to the Loans will be subject to this Agreement.
6. Nature of Transferee's Participation Interest. Transferee's obligations hereunder constitute absolute, unconditional and continuing obligations to make funds or credit available to Transferor for Transferor to extend credit to any of the Borrowers and pay letters of credit issued for the account of any of the Borrowers pursuant to the terms of the Loan Documents and will be unaffected by (i) any amendment or waiver of any term of the Loan Documents, (ii) any extension, overadvance, indulgence, settlement or compromise granted or agreed to in relation to the Loan Documents, (iii) the release of any Collateral or any guaranty of the Loans, (iv) any invalidity, unenforceability, or insufficiency of the Loan Documents or of any drafts or other documents submitted in connection with draws under any letters of credit, (v) any default by or insolvency of any of the Borrowers, (vi) any act or omission on Transferor's part relating to this Agreement or the Loan Documents (absent gross negligence or willful misconduct), (vii) the absence of notice to Transferee of any of the foregoing, (viii) any requirement that Transferor
take any action against any of the Borrowers or any other person liable on the Loans, and (ix) any defenses in law or equity which Transferee may have to the full discharge of its obligation under this Agreement (absent gross negligence or willful misconduct by Transferor).
7. Servicing of the Loans. Transferor shall service the Loans on behalf of both Transferee and Transferor as follows:
(a) Except as otherwise specifically set forth in this Agreement, Transferor will perform the servicing for the Loans or will cause an affiliate of Transferor to service the Loans. For this purpose, servicing shall include all communications with any of the Borrowers and third parties, making of all advances and issuing of letters of credit provided for under the Loan Documents (subject to receipt from Transferee of its Participation Share of each such advance), receipt of all collections under the Loans and remittance of the same to the party entitled thereto, inspections of the Collateral, and all other acts incidental thereto. Transferor shall use good faith efforts, or shall cause its affiliate to use good faith efforts, to collect all payments due under the Loans as they become due and payable and to enforce all obligations of the Borrowers to the extent necessary to protect the interests of Transferor and Transferee. Transferor shall administer all Loan collections, including any escrows, in accordance with all applicable laws and regulations. Transferee agrees that such funds may be commingled with Transferor's general funds.
(b) Transferor shall have the right in its discretion to
give consents, waivers and modifications of the Loan Documents to the same
extent as if the Loans were wholly owned by Transferor; provided, however, that
(i) no waiver of any payment default, (ii) no extension of the maturity, (iii)
no reduction of the rate or rates of interest with respect to the Loans, (iv) no
forgiveness or reduction of the principal sum of the Loans, (v) no increase in
the lending formula or advance rates, (vi) no waiver of any right to elect to
foreclose on any Loan in default, and (vii) no amendment or modification of the
financial covenants contained in the Loan Documents that would make such
financial covenants less restrictive with respect to any of the Borrowers, shall
be made without the prior written consent of Transferee. Transferor shall have
the right to accept payment or prepayment of the whole principal sum and accrued
interest in accordance with the terms of the Loans, waive prepayment charges in
accordance with Transferor's policy for Loans in which no participation is
granted, and accept additional security for the Loans.
(c) On or before the date of execution of the Loan Documents, with respect to the principal sums already advanced and outstanding pursuant to the Loans as of such date, and on or before any later date when funds are to be disbursed to any of the Borrowers pursuant to the Loans or a drawing occurs under any letter of credit, Transferee shall pay to Transferor its pro rata share, in accordance with its Participation Interest, of the amount of the disbursement or letter of credit payment (or, with respect to principal sums already advanced and outstanding as of the date of the execution of the Loan Documents, the aggregate principal balance of the Loans as of such date), in funds available for immediate use, by 2:00 p.m., Columbus, Ohio, time, on the same banking day on which the advance is made (or, with respect to the principal sums already advanced and outstanding pursuant to the Loan Documents as of the date of the execution of the Loan Documents, provided, however, that Transferor shall use its best efforts to give Transferee advance notice of such funding request no later than 10:00 a.m., Columbus,
Ohio, time, on such day. If Transferee fails or refuses to make payment to Transferor as required herein, then Transferor, without limitation, shall be entitled to pursue all remedies and rights permitted by this Agreement, law, or equity against Transferee and further shall be entitled to, but not be required to, (i) fund Transferee's Pro Rata Share of the disbursement, and (ii) accrue interest on any unpaid amount at the Federal Funds Rate, and (iii) withhold from Transferee all interest, principal, fees and late charges attributable to Transferee's Pro Rata Share thereof through the date Transferee funds its Pro Rata Share thereof and pays the interest due thereon, plus any additional cost or expense, including without limitation, reasonable attorneys' fees, incurred by Transferor as a result of Transferee's failure to pay, and (iv) offset against Transferee's Pro Rata Share all sums received by Transferor in connection with the Loans until reimbursed by Transferee for such payment and interest thereon. All payments received by Transferor in respect of the Loans shall be distributed pro rata to Transferee promptly after Transferor shall have collected such payment or payments in immediately available funds.
(d) Transferor and Transferee shall share in proportion to their Participation Shares in all payments of principal and interest made on the Loans after the date of transfer of the Participation Interests. Transferor and Transferee shall share in any prepayment, late charges, or any other fees or charges associated with the Loans which are actually collected subsequent to the time of transfer of the associated Participation Interest, in proportion to their Participation Shares. Transferor shall not be required to remit any such principal, interest, prepayment, late charge, or any other fee or charge associated with the Loans, unless it is actually collected from the Borrowers.
(e) To the extent not reimbursed by the Borrowers, and without limiting the obligation of the Borrowers to do so, Transferee agrees to reimburse Transferor, to the extent of Transferee's pro rata share, for any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind whatsoever, including without limitation disbursements necessary in the judgment of Transferor to preserve or protect any Collateral (but excluding costs of ordinary overhead and salaried expense of Transferor's clerical and supervisory personnel), that may at any time be imposed on, incurred by, or asserted against Transferor in any way relating to the Loans, the Loan Documents, any letters of credit issued pursuant to the Loan Documents or the Loan Documents, any collateral, the transactions contemplated thereby or hereby, or any action taken or omitted by Transferor under or in connection with any of the foregoing provided, however, that Transferee shall not be liable for the payment of any portion of the foregoing which result directly from Transferor's gross negligence or willful misconduct. The covenants contained in this paragraph shall survive the termination of this Agreement and the expiration of any letters of credit issued pursuant to the Loan Documents.
(f) Transferor shall at all times keep proper books and records in accordance with generally accepted accounting principles consistently applied, reflecting all transactions in connection with the Loans. All such records shall be accessible for inspection by Transferee at all reasonable times during Transferor's business hours. Transferor shall use its best efforts to provide the following information to Transferee within a reasonable time after such information becomes available to Transferor:
(i) The accrual status of the Loans;
(ii) The status of principal and interest payments;
(iii) Financial statements of the Borrowers; and
(iv) Information regarding the value of the Collateral and the status of Transferor's liens.
(g) Transferor may accept deposits from, make Loans or otherwise extend credit to any of the Borrowers and generally engage in any kind of banking relationship with, any of the Borrowers or any other person or entity having obligations relating to the Loans, the Loan Documents, or any related agreement and receive payment on such Loans or extensions of credit and otherwise act with respect thereto freely and without accountability in the same manner as if this Agreement did not exist. Transferor, without liability, may rely upon the advice of legal counsel, accountants or other experts (including those retained by the Borrowers) and upon any written communication or any telephone conversation which Transferor believes to be genuine and correct or to have been signed, sent or made by the proper person or entity, shall not be required to make any inquiry