With the banking industry on the mend, there could be good times ahead for investors in Huntington Bancshares (NASDAQ:HBAN).
However, while there might be some key trends moving in Huntington's favor, its success is far from a given. As a result, investors interested in Huntington will want to keep a very close eye on the following three areas.
Saying that the economy is an area investors must watch is probably one of the most obvious statements made in this still-young century. But it's both true and slightly more nuanced than it seems, because it dictates not only the ability of borrowers to repay their obligations to banks but also the direction of interest rates set by the Federal Reserve.
There are two specific economic indicators that investors should keep their eyes on. The first is the unemployment rate. As you probably know, the Fed operates pursuant to a so-called dual mandate, under which its Board of Governors is charged with minimizing both unemployment and inflation. Its primary tool for combating the former is monetary policy, which it uses to manipulate interest rates, which, in turn, are the primary drivers of a bank's profitability.
The impact of the Fed's actions has been particularly severe of late, as its monetary policymakers move to drive down the long-term interest rates that banks rely on to make money. For example, shares in Huntington's competitor BB&T (NYSE:TFC) fell by more than 10% after it, the nation's 11th largest bank by assets, revealed that its net interest margin -- a tailored average of the difference between higher long-term interest rates and lower short-term rates –. fell by 15 basis in the most recent quarter. While Huntington's didn't dive as deeply, it's nonetheless something that investors need to watch.
The second economic indicator – or rather, group of indicators – that investors must watch concerns housing values and sale volumes. It's no exaggeration to say that banks are in the real estate business, as a large proportion of loans are collateralized by residential houses and/or commercial real estate. Consequently, any improvement or degradation in real estate values will filter down to a bank like Huntington's bottom line.
A well-known and extremely rich investor once said that banks fail for one reason: They make bad loans. This simple but prescient observation remains true despite the introduction of the destructive financial products that are widely blamed for fueling the crisis five years ago. Of the nearly 500 banks that have failed since the beginning of 2007, the vast majority had likely neither seen nor even heard of these purportedly sophisticated Wall Street innovations. They failed instead as a result of making bad loans.
There's both good and bad news on this front when it comes to Huntington. The good news is that the quality of its loan book is improving with each passing day. Since the nadir of the financial crisis, its ratio of nonperforming loans to total loans has fallen from 5.9% down to just over 1%, and its quarterly provisions for loan losses has plummeted by a staggering 96% from its peak in the fourth quarter in 2009.
Alternatively, the bad news is that Huntington's credit metrics remain elevated relative to better-situated peers and its own pre-crisis condition. Before 2008, Huntington regularly sported a nonperforming loan ratio of 0.5% or lower, and its Buffalo, N.Y.-based competitor First Niagara Financial Group (NASDAQ: FNFG) currently comes in at 0.7%. With this in mind, it seems less like a mere coincidence that First Niagara was able to outbid its rivals for HSBC's (NYSE:HSBC) massive operations in New York state in 2011.
Investors should accordingly watch the direction of trends in Huntington's credit metrics. Absent exogenous explanations, such as the regulatory guidance that affected these metrics across the industry in the third quarter of 2012, anything that looks like deterioration should immediately raise your concern.
Growth is an important, if not essential, trait for any company. But growth through acquisitions can cut both ways, as pursuing it recklessly and singlemindedly is a certain recipe for disaster.
There are two textbook examples of this in the banking industry. The most infamous concerned Ken Lewis' now-fateful decisions to purchase Countrywide Financial and Merrill Lynch in 2008, when he was the chairman and CEO at Bank of America (NYSE:BAC). Needless to say, these acquisitions have since nearly bankrupted the nation's second largest lender by assets.
The second and lesser-known example strikes straight to the heart of Huntington's current trajectory. In 2006, under then-CEO Thomas Hoaglin, Huntington acquired Sky Financial, a diversified financial services company that, among other things, provided warehouse credit facilities to subprime mortgage originators akin to Countrywide. One such originator, Franklin Credit Management Corp., subsequently went under, leaving Huntington in the lurch for more than $1 billion and prompting Hoaglin to resign.
With this in mind, it's imperative that investors closely monitor Huntington's acquisitions as it strives to gain market share. This hasn't been a problem thus far, because its new CEO, Stephen Steinour, has adroitly targeted only deeply discounted lenders to purchase from the FDIC. But if this were to change in the future, you should reassess your investing thesis for Huntington.