Huntington Bancshares: Solid Q1 Leaves Shares With Further Upside (NASDAQ:HBAN)

Shares of Huntington Bancshares (NASDAQ:HBAN) traded modestly higher on Friday after reporting solid Q1 earnings. The stock has been a laggard over the past year rising just 12% while the S&P 500 has rallied by about 20% as investors still grapple with the aftershocks of the 2023 regional banking crisis. HBAN has performed much better since I rated shares a “strong buy” in October with a 40% gain that has doubled the market’s return. In this rally, shares have eclipsed my $12 target, making now a natural time to revisit the stock. I remain bullish.

In the company’s first quarter, Huntington earned $0.28 in adjusted EPS, besting consensus by $0.03. Adjusted results excluded a one-time payment to the FDIC as the entity recoups losses from bailing out depositors at troubled banks last year. Earnings were down from $0.39 last year as higher funding costs across the industry have pressured net interest margins (NIM). Net interest income declined by $27 million to $1.3 billion as NIM compressed 6bps to 3.01%. Importantly, we are seeing the worst of these pressures fading, and I continue to be impressed by HBAN’s deposit gathering ability.

Across all of my analysis on regional banks, I have highlighted a stable deposit base as a prerequisite for investing in the sector, given the centrality of deposits in a bank’s capital structure. After Silicon Valley Bank failed, we saw many banks wrestle with deposit outflows. This is an area where HBAN has done quite well, which underpinned by bullish thesis back in October. Deposits are up by 3.1% from last year. They rose 0.7% or about $1 billion sequentially from Q4. Often, deposits can fall in Q1 after a seasonal build in Q4, so this growth was impressive. Consumer deposits have risen for 16 straight months.

Because HBAN is primarily funded by consumers and accounts below the FDIC insurance limit, its deposit base has been less susceptible to panics. That said, the cost of retaining and growing deposits has been significant given broader pressures and the rate environment. Total deposit costs rose by 15bp in Q1 to 2.29%; that is the smallest increase since Q2 2022. While I expect a further increase in Q3, assuming the Federal Reserve does not raise interest rates, we are likely 3-6 months from a peak in funding costs.

Besides paying more for interest bearing deposits, mix shift has also been a funding cost headwind. Here, the magnitude of the headwind should be narrowing. Noninterest bearing balances declined by $1.3 billion in Q1, a bit slower than the $1.6 billion drop in Q1 last year. At 19.4% of deposits, this share is down over 12 percentage points from three years ago and below pre-COVID levels. Most NIB accounts are transactional (a payroll account for instance), so there is a functional floor to these balances as clients need sufficient funds to meet transactions. With outflows slowing and the share of deposits back to pre-COVID levels, we are likely near the floor. Management expects net interest income to rise sequentially over 2024, and given these trends in deposits, I expect this to occur.

Thanks to its growing deposit base, HBAN continues to deploy capital. Loans grew by $1.6 billion or 1.3% from last year to $123 billion. Loan growth has been focused on business, not commercial real estate, lending, which I view favorably given the challenges facing real estate. Credit quality remains strong with just 0.3% of net charge-offs, at the low-end of HBAN’s long-term 0.25-0.45% target. As you can see below, there has been a modest increase in nonperforming loans, but they remain relatively muted. HBAN has also set aside 1.97% of loans in reserves for losses. That provides 3.3x coverage of NPAs, above my 2.5x benchmark of healthy reserves. In other words, credit quality could deteriorate further before HBAN needs to build more reserves.

Additionally given deposit growth, HBAN’s $41.6 billion securities portfolio grew by $2.1 billion sequentially as it deployed cash and bought bonds at an average yield of 5.27%. With funding costs below 2.3%, this is an attractive net spread, and it is above the portfolio’s 4.19% yield. The portfolio has a 3.5 year duration, down from 3.7 billion last quarter, reducing its interest rate sensitivity.

Still, given the fact bonds have been bought at lower yield levels, HBAN has a $2.9 billion loss in accumulated other comprehensive income (AOCI), about $200 million worse than Q4 as rates rose in Q1. By the end of 2025, this should fall to $2.2 billion, assuming current market forward pricing.

Currently, AOCI is not included in HBAN’s capital calculations, and it has a 10.2% common tier 1 equity ratio (CET1). At the end of next year, HBAN will need to begin phasing AOCI into its capital ratios. Including its AOCI loss, capital would be 8.5% today, safely above the regulatory minimum. HBAN is targeting a 9% adjusted CET1, and this is why it is holding headline capital above its targeted level to prepare for AOCI’s inclusion. With retained earnings, it is on track to hit this 9% adjusted level by year end, even if the Fed does not cut rates this year.

I would also note that HBAN should see some ongoing improvement in noninterest income. Wealth and asset management fees rose 10% from a year ago and 2% sequentially as AUM is up 12%. Strong markets should be an ongoing tailwind as they lift AUM and advisory revenue. Capital markets fees were 14% lower from last year, but with an increasing pace of loan originations and growing advisory pipeline, we should see a meaningful acceleration. At the same time, HBAN is controlling costs; adjusted operating expenses fell by 2% sequentially to $1.1 billion.

Given these solid results, HBAN left its full year guidance unchanged from last quarter.

Back in October, I argued HBAN could earn up to $1.40 with the potential to resume share repurchases in Q4 or Q1 2025. With capital set to reach target around year-end, I would look for repurchases to begin at the beginning of next year. With rates staying higher for longer, the AOCI loss will decline more slowly, making Q4 buybacks less likely in my view. With net interest income set to increase each quarter and credit quality also improving, I expect HBAN to earn $1.25-1.40 this year, depending on how quickly deposit pricing moderates.

This gives shares a 10x multiple on 2024 earnings with a secure 4.7% dividend yield and buybacks on the horizon. Given the rally, I no longer see shares as a “strong buy,” but I still view them as a “buy” as HBAN has a proven it has a strong and durable deposit franchise with interest income turning the corner. Most strong regional banks, like PNC (PNC), Fifth Third (FITB), Ally (ALLY), and US Bancorp (USB) trade 10.5-12x earnings. I believe HBAN belongs in this caliber of banks and can see its multiple gradually move towards 11-12x, which can push shares towards $15. With 12% upside and an 4.7% dividend yield, HBAN still offers an attractive return opportunity, and as such, it should be bought, even after its recent run.