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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings and welcome to the Huntington Bancshares Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Mr. Mark Muth, Director of Investor Relations. Please go ahead.
Thank you, Melissa. Welcome, I'm Mark Muth, Director of Investor Relations for Huntington. Copies of the slides we will be reviewing can be found on the Investor Relations section of our website at www.huntington.com. This call is being recorded and will be available as a rebroadcast starting about one-hour from the close of the call.
Our presenters today are Steve Steinour, our Chairman, President and CEO; Zach Wasserman, Chief Financial Officer; and Rich Pohle Chief Credit Officer. As noted on Slide 2, today's discussion, including the Q&A period will contain forward-looking statements. Such statements are based on information and assumptions available at this time and are subject to changes, risks and uncertainties which may cause actual results to differ materially. We assume no obligation to update such statements. For a complete discussion of risks and uncertainties, please refer to this slide and material filed with the SEC including our most recent Forms 10-K, 10-Q and 8-K.
Let me now turn it over to Steve.
Thanks, Mark, and thank you to everyone for joining the call today.
Slide 3 provides an overview of Huntington strategy to build the leading People-First, Digitally-Powered bank in the nation, which the Board affirmed this year and our multi-year strategic planning process. Huntington's strategies are delivering long-term revenue growth. As our third quarter results demonstrate, we are driving revenue growth despite headwinds of the current environment.
We're focused on acquiring new customers and deepening those relationships to gain both market share and share of wallet. We are investing in customer-centric products, services and infrastructure that will drive sustainable growth and our performance both today and for the years to come.
Huntington has built a competitive advantage with our consistently superior customer service and our differentiated products and services. We are committed to developing best-in-class digital capabilities like our mobile banking app, which has been audited by J.D. Power, two years in a row, and our online banking, which was number two in this year's J.D. Power study.
In the past few weeks, we introduced several new innovative products and features that will continue to serve our customers' needs and differentiating Huntington from our competition. First, we extended 24 Hour-Grace to businesses, we then introduced our no-fee overdraft $50 Safety Zone for both consumers and businesses, and finally, earlier this week, we announced our latest innovation Huntington Lift Local Business, the $25 million micro lending program that capitalizes on our best-in-the-nation SBA lending expertise to better serve minority women and better-known businesses. We've intentionally diversified business models, balanced between commercial and consumer, which provides diversification of revenue and credit risk.
We have a proven track record of solid execution adjusting our operating plans to the environment in order to drive shareholder returns. This has allowed us to deliver seven consecutive years of positive operating leverage and I expect 2020 will be our eighth. This focused execution has and will was to ensure investment in the products, people, and digital capabilities that will drive sustainable long-term growth and our performance.
Turning to Slide 4 for an update on our digital and branch strategies, following the completion of the FirstMerit acquisition in 2016, we began the evolution of our consumer go-to-market strategy from being branch centric to a powerful multi-channel model that includes leading digital channels.
We introduced the Hub, which forms the backbone of our award-winning mobile app and our online banking platform. That evolution has accelerated this year with increased customer adoption of mobile and digital products and services, and we are successfully driving digital sales and originations, as well as changing and expanding the branch experience to include virtual and digitally assisted delivery.
Our branch sales activity is almost back to pre-COVID levels, it is about 95% today, but we're seeing an accelerating evolution of the way our customers use branches. Simpler transactions are rapidly moving into faster and easier mobile and digital venues. This transition is allowing our branch bankers to focus on providing more valuable advice and focusing on deepening our customer relationships, all ways of looking out for our customers.
As we've discussed previously and as shown on the bottom of the slide, Huntington regularly evaluates and optimizes our branch distribution, since the completion of the FirstMerit acquisition in 2016, we have reduced our branch count by 263 branches or 24%. This includes the consolidation of 99 branches or 9% as part of the integration, the sale of 32 branches in Wisconsin and the consolidation of an additional 132 branches or 4% annually on average since 2016.
Last month, we announced the planned consolidation of 27 additional branches or 3% in the 2021 first quarter. We're pleased with the high retention levels post consolidation of deposits due to the strong foundational relationships with our customers and the close proximity to other Huntington branches as we have maintained our branch share position in almost all markets.
This thoughtful branch network optimization strategy allows us to continue to capitalize on our competitive advantages around convenience, our brand promise and customer service. If you did not listen to Andy Harmening's presentation on our digital transformation at an Investor Conference in early September, I encourage you to visit our Investor Relations website and listen to the replay and see the presentation materials.
I believe our digital strategy and our execution of that strategy is generating industry-leading results. We delivered very strong third quarter results including a record level of pre-tax pre-provision earnings, thanks to continued solid execution across the bank in the face of a continued challenging operating environment. I am particularly pleased with our year-over-year revenue growth as earning asset growth more than offset NIM compression to drive spread revenue modestly higher, while fee income growth was bolstered by the second consecutive quarter of record mortgage banking income.
The performance of our home lending team was outstanding. They originated more than $3.8 billion in mortgages for the second consecutive quarter. To frame that for you, our previous high watermark for any quarter was $2.5 billion of mortgage originations in the fourth quarter of last year. Our combined mortgage production over the past two quarters was greater than we did in all of 2018 and roughly the same as in all of 2019.
So these accomplishments were the direct result of the successful build-out of this team and our investments in our digital mortgage lending platform over the past several years. We're well positioned to capitalize on the current mortgage environment and the near-term outlook remains strong.
Given the prolonged low interest rate outlook, we have implemented a comprehensive action plan to stabilize NIM near current levels over the long term. Zach will cover this and more in his remarks.
We continue to closely manage our expenses. A significant portion of the year-over-year increase in expenses resulted from restructuring costs related to implementation of expense management program we announced last quarter and elevated variable costs to support our record home lending business volumes. As we previously discussed, our efforts have been to manage expenses so that we can allocate investments to our strategic growth initiatives.
Looking forward, we remain optimistic of the continuing economic recovery, the unprecedented level of government stimulus has supported both individuals and many companies, we're very pleased with the number of customers exiting forbearance arrangements.
Our consumer lending businesses, which as you've seen in our quarterly originations dated provided for a decade are focused on super-prime customers and they're performing very well. Mortgage, auto, and RV marine are all continuing to post strong originations.
Commercial lending has been restrained by the economic uncertainty, many customer shepherding elevated levels of liquidity, paying down revolvers and putting off new investment spending. We have continued to see improvements in commercial pipelines that we mentioned last quarter and based on the conversations we've had with our customers; we expect these levels of elevated liquidity to persist for some time. We're cautiously optimistic that C&I loan growth will improve later this year and early next year.
The timing of forgiveness around the PPP loans remains uncertain. But I would like to take a moment to share that Huntington was the nation's largest SBA 7(a) lender for the third consecutive year in the SBA's fiscal year ended September 30. We are the largest 7(a) lender in our footprint with a 12 year in a row.
Small businesses are such a vital component of our economy in the nascent economic recovery as they consistently account for the lion's share of jobs created in our country, particularly this pandemic these businesses deserve and need our support and I hope these businesses are the focus of any future government stimulus package.
Our third quarter credit metrics reflect stable to improving trends across most portfolios and include elevated charge loss from the sale of more oil and gas loans. During the quarter, many customers successfully exited prior pandemic related deferral programs. The underlying portfolio metrics reflect our continued expectation for outperformance through the cycle. Our credit loss reserves take into consideration the economic uncertainty that we continue to have the virus both in duration and severity.
We believe we're adequately covered should the pandemic continue to prolong the economic recovery. Our capital ratios remain within our targeted ranges. This morning we announced that the Board declared the fourth quarter cash dividend of $0.15 per common share unchanged from the prior quarter. We are currently finalizing our submission for the off-cycle CCAR. We are seeking approval and expect to increase our capital return to shareholders in 2021.
In closing, I am encouraged by the momentum I can see building across our businesses. Our colleagues are actively engaging with our customers and prospects, customer activity is improving month-by-month, we see improved debit card activity, sales activity in the branches is almost back to pre-COVID levels and our pipelines have been replenished in many of our businesses over the past several months.
We recently made some key additions to our commercial team notably within our Asset Finance Capital Markets and Corporate Banking teams and have conversations ongoing with additional revenue producers. We're seeing very, very positive feedback and early results from the new 24-hour Grace for business and the $50 Safety Zone product features for consumers and businesses that we rolled out in September.
Our credit quality through the early months of this pandemic has held up well and we're confident in the quality of our loan portfolios. I am conscious that the economic outlook remains somewhat uncertain in the near-term but overall and likewise and optimistic about our outlook over time.
Now let me turn it over to Zach for an overview of financial performance. Zach?
Thanks, Steve and good morning everyone.
Slide 5 provides the financial highlights for the 2020 third quarter. We reported earnings per common share of $0.27. Return on average assets was 1.01% and return on average tangible common equity was 13.2%. Results continue to be impacted by the elevated level of credit provision expense as we added $57 million to the reserve during the quarter.
Now let's turn to Slide 6 to review our results in more detail. Year-over-year pre-tax pre-provision earnings growth was 2%. We believe this is a solid performance in light of the current interest rate environment and uncertain economic outlook. Total revenue increased 5% versus the year ago quarter, due to the strong fee income growth paired with modest spread revenue growth.
As Steve mentioned earlier, home lending was a particular bright spot this quarter, driving a record $122 million of mortgage banking income. We also saw deposit service charges, and card and payment processing revenues rebound off the 2Q lows as customer activity continued to rebound and pandemic related fee waiver programs expired. I should also note that deposit service charges remain below the year-ago level as elevated consumer deposit account balances continue to moderate the recovery of this line.
Total expenses were higher by $45 million or 7% from the year ago quarter. As Steve mentioned, approximately 2 percentage points of this growth or $15 million was driven by restructuring costs from our 2020 expense management program, another 3 percentage points, or $18 million was related to year-over-year increases in commissions over time, contract help and other variable costs in our home lending business driven by the record level of mortgage originations. The balance of the expense growth, approximately 2% reflected a sustained level of investment in our strategic priorities including digital and mobile technology.
Turning now to Slide 7, FTE net interest income increased 2% as earning asset growth more than offset year-over-year NIM compression. On a linked quarter basis, the net interest margin increased 2 basis points to 2.96% as shown in the block on the right side of the slide, the linked quarter increase included a 7-basis point benefit from our hedging program, including the fourth quarter impact of the $1.6 billion of forward starting asset hedges that became active in the second quarter. There was also a 2-basis point benefit during the third quarter related to changes in balance sheet mix and other items.
These two positive impacts were partially offset by the elevated balance sheet liquidity that contributed a 7-basis point incremental headwind in the third quarter. As Steve mentioned, we're taking decisive actions to maintain the net interest margin near current levels while we are diligently working across the organization to identify and pull levers to manage the margin.
It's important to note that our core optimization objective is revenue growth with the highest possible return on capital within our risk appetite. That said, NIM is one of the key drivers of that return and revenue growth, so we're actively managing various levers to stabilize the NIM as a key component in that calculus.
We expect to continue to optimize our funding costs including further reductions to deposit costs and optimizing our wholesale funding. On the earning asset side, we're currently in the midst of a broad re-examination of all business and lending commercial relationships for repricing opportunities that I believe will yield several basis points of incremental NIM over time as well as associated deepening of non-interest income fee opportunities.
Similarly, we are optimizing our earning asset mix by emphasizing loan production in certain higher yielding asset classes such as small business, residential mortgage, asset-backed lending, equipment leasing while de-emphasizing growth in some of our thinner priced lending products.
Finally, our comprehensive hedging strategies continue to provide some relief from the yield curve as we expect they will continue to do for the next several years. While this hedging benefit will begin to gradually wane over the next several years, there are no looming cliffs as we have strategically built a well-laddered hedging portfolio.
Moving to Slide 8, average earning assets increased to $11 billion or 11% compared to the year ago quarter, driven by the $6 billion of PPP loans and a $5 billion increase in deposits of the Fed. Average commercial and industrial loans increased 13% from the year ago quarter, primarily reflecting the PPP loans.
During the quarter, C&I benefited from a full quarter's impact of the PPP loans; however, downward pressure on the business and commercial utilization rates, especially within dealer floor plan more than offset this resulting in a modest linked quarter decline. Consumer lending has also been a bright spot this year as indirect auto, residential mortgage and our RV marine portfolios have posted steady growth, a trend we expect to persist in coming quarters.
Turning to Slide 9, we will review the deposit growth. Average core deposits increased 14% year-on-year and 2% sequentially. These increases were driven by business and commercial growth related to the PPP loans and increased liquidity levels in reaction to the economic downturn, consumer growth largely related to the government stimulus and increased consumer and business banking account production and reduced account attrition. Like the industry as a whole, this is very strong core deposit growth in the past several quarters has resulted in significantly elevated levels of deposits at the Federal Reserve Bank.
These elevated levels of liquidity have proven to be much stickier than we anticipated and our revised outlook is that they are likely to persist for several quarters before these customers deploy the funds. While this did pressure in the Q3 NIM more than originally expected, it is also providing us the opportunity to more aggressively manage down our deposit costs going forward.
Slide 10 highlights the more granular trends in commercial loans, total deposits, salable mortgage originations and debit card spend as these are key indicators of behavior and economic activity amongst our customers. As you can see on the top left chart, the decline in commercial loan balances excluding PPP loans leveled off in July and remained relatively flat during the third quarter.
Early stage pipelines are refilling providing room for optimism of a return to new commercial loan growth later this year and into next year. We expect this coupled with the expected gradual normalization of commercial utilization rates and the typical seasonal build in dealer floor plan will provide some offset from the headwinds from PPP loans as they are forgiven and repaid over the next several quarters.
The top right chart reflects the continued elevated deposit balances resulting from the factors I've mentioned previously, providing attractive source of liquidity during these uncertain times. The bottom two charts relate to customer activity driving two of the four key fee income lines for us. Mortgage banking salable originations remain robust, although there has been a very slow decline since the peak in June.
As we mentioned on the second quarter call, debit card usage quickly rebounded once the economy began to be re-open and we continue to see healthy year-over-year increases in both transactions and dollar spend.
Slide 11 illustrates the continued strength of our capital and liquidity ratios. The common equity Tier 1 ratio or CET1 ended the quarter at 9.89%, relatively stable with last quarter. The tangible common equity ratio or TCE ended the quarter at 7.27% again in line with last quarter. Both ratios remain within our operating guidelines and our strong capital levels position us well to execute on growth initiatives and investment opportunities.
Let me now turn it over to Rich Pohle to cover credit. Rich?
Thanks Zach.
I first like to reinforce the steps we've taken over the last several years to position us for this downturn. In commercial, we scaled back leverage lending, health care, construction and commercial real estate. We stopped originating oil and gas loans about 18 months ago and reduced debt portfolio to well under 1% of total loans.
We have also repositioned our business banking portfolio with a significant reduction in commercial real estate exposure and a shift toward SBA as about 20% of our loans are now SBA as opposed to only about 5% heading into the last downturn.
We were the number one bank in the entire country last year for SBA 7(a) originations for the third consecutive year. On the consumer side, we had continued our focus on prime and super-prime profile customers and leveraged our expertise in auto into our RV marine business.
Turning now to the credit results and metrics. Slide 12 provides a walk of our allowance for credit losses or ACL from year-end 2019 to the third quarter. You can see our ACL now represents 2.31% of loans and excluding the PPP loan balances, our ACL would be 2.5% as of September 30. The third quarter allowance represents a modest $57 million reserve build in the second quarter. Like the previous quarters in 2020, there are multiple data points used to size the provision expense for Q3. The primary economic scenario within our loss estimation process was the August baseline forecast.
This scenario was somewhat improved from the May baseline forecast we used in Q2 and assumes elevated unemployment through 2020 ending the year at 9.5% followed by a slower paced economic recovery through the first half of 2021 that accelerates as the year progresses. 2020 GDP for the full year down 4.9% and demonstrates 2.6% growth for all of 2021 with that growth also accelerating in the back half of the year.
While a number of variables within the baseline economic scenario has improved, as of our credit metrics for the quarter, there are still many uncertainties to deal with, the likely COVID a resurgence in the winter, a stalemate on additional economic stimulus, the impact of these coming upcoming election as well as ongoing model imperfections relating to the COVID economic forecasting. We believe maintaining coverage ratios consistent with the second quarter is prudent when considering these factors.
Slide 13 shows our NPAs and TDRs and demonstrates the continued impact that our oil and gas portfolio has had on our overall level of NPAs. Oil and Gas NPAs for Q3 represented 26% of our overall NPAs which were down from the second quarter by $111 million or 16% as we proactively reduced the oil and gas portfolio and were able to return other credits to accruing status.
Slide 14 provides additional details around the financial accommodations we provided to our commercial customers. As we forecasted on our Q2 call, the commercial deferrals have dropped significantly and now total just $942 million, down from $5 billion at June 30, about 80% of the remaining deferrals represent second 90-day deferrals that are centered on hospitality, retail and travel related customers.
Over 70% of the remaining deferrals expire this month and we expect to have limited commercial deferral balances at the end of Q4. Some SBA customers might seek an initial deferral in Q4 following the end of the six-month payment support the SBA provided under the CARES Act. Commercial delinquencies are within a normal range at 19 basis points reinforcing the deferrals have not negatively impacted credit quality.
Slide 15 shows our consumer deferrals and the news here is good as well. Our auto, RV marine and HELOC portfolios are performing as we would have expected with very modest close deferral delinquencies, in fact, nearly all the auto, RV marine, HELOC deferrals have lapsed and we are operating in a pre-COVID risk management environment with respect to those portfolios. The mortgage accommodations have come down 78% since June and are also meeting our expectations.
Request for second deferrals or further modifications equal just 10% of the post deferral population today. Mortgage deferrals will remain elevated for the next quarter or so given the longer additional deferral period 180 days in many cases versus 90 for other loans, as well as the more formal deferral exit process which requires a second round of documentation with wet signatures and deliveries.
Like the commercial deferrals, the consumer deferrals are not indicating additional credit risk at this time. Consumer delinquencies were down across all loan categories on a year-over-year basis.
Slide 16 provides an update to the industries hardest hit by COVID-19. We continue regular reviews of our commercial loan portfolio and we believe we have the risks identified and appropriately managed. Any adverse COVID impacts, as well as the most recent SNIC exam results are reflected in our [trip] class and other credit metrics for the quarter.
As we had previously mentioned, our hotel exposure centered on five primary sponsors with most of whom we've enjoyed long-term relationships, including through the last downturn, these sponsors continue to demonstrate the financial strength to see their way through the longer-term recovery period we forecast for this industry.
Our restaurant exposure is primarily in the national quick service brands. We believe this book to be in very good shape overall while we continue to closely monitor the heightened risk at a single location and other non-franchise names in the portfolio. There are currently no material credit concerns in the other high-impact portfolios and you can see that the credit metrics since June are relatively stable.
Recall in the second quarter as part of our active portfolio management process, we evaluated the COVID related impacts across all portfolios and took appropriate actions to downgrade those severely impacted credits to criticized status. This review resulted in a significant increase to our criticized asset level in Q2.
I am pleased to report our level of criticized loans was reduced by over $425 million or 12% in the third quarter validating that the portfolio review we undertook in Q2 was comprehensive and served to identify potential problems early. Working with our customers, we're able to proactively remedy a number of these loans.
Slide 17 provides a snapshot of key credit quality metrics for the quarter. Our credit performance overall was strong. Net charge-offs represented an annualized 56 basis points of average loans and leases. The commercial charge-offs were again centered in the oil and gas portfolio, which made up approximately 44% of the total commercial net charge-offs. Like Q2, nearly all these oil and gas charge offs resulted from $127 million of loan sales closed or contracted for sale during the quarter as we prudently reduced our exposure to this industry.
Annualized net charge-offs excluding the oil and gas-related losses were 36 basis points, demonstrating that the balance of our portfolio continued to perform well in Q3. Consumer charge-offs were just 24 basis points in Q3, highlighting our strong consumer portfolio.
Our super-prime originations of auto and RV marine loans in particular continue to perform at very high levels. I would also add our non-performing asset ratio decreased 15 basis points linked quarter to 74 basis points. As always, we have provided additional granularity by portfolio in the analyst package in the slides.
Let me turn it back over to Zach.
Thank you, Rich.
As Steve alluded to earlier, we have confidence in our businesses and are cautiously optimistic that the economic recovery will continue, particularly longer term as we move past the election and with the potential for vaccine and improved therapeutic medical treatments for the virus. We also expect to finish out 2020 strong and Slide 18 provides our expectations for the full year of 2020.
Looking at the average balance sheet for the full year 2020, we expect average loans and average deposits to increase approximately 6% and 10% respectively compared to last year. For the remainder of the year, we expect consumer loans, more specifically residential mortgage, auto, RV marine to be the primary driver of average loan growth as commercial loan growth remains muted.
Our current projections assume the majority of PPP balances will remain on balance sheet through the end of the year. With respect to deposits, we expect continued growth in consumer core deposits from new customer acquisition, relationship deepening and low attrition. As I mentioned earlier, we expect the elevated level of business and commercial deposits to persist through year-end.
We expect to record full-year total revenue growth of approximately 3% to 3.5% and full-year total expense growth of 2% to 2.5%. With respect to revenues, we expect Q4 revenues to be in line with Q3, up 7% to 8% year-over-year.
We expect full year NIM to be approximately 300 basis points and we expect a flat to moderately higher NIM in the fourth quarter, driven primarily by further reductions to the cost of interest-bearing deposits, which we expect to be below our prior historic low of 22 basis points that we set back in the third quarter of 2016. This guidance includes no positive impact in Q4 from the acceleration of PPP fees and includes a continuation of elevated liquidity that we discussed earlier.
We expect full year non-interest income growth of 8% to 10% primarily driven by robust mortgage income while our fourth quarter outlook includes moderation in mortgage banking. We expect an uptick in capital markets fees as well as several other fee lines to help to cushion that decline.
On expenses, we expect the fourth quarter to be up 3% to 5% from the third quarter. As we've discussed before, we believe the current economic outlook presents the opportunity to invest in our businesses in order to meaningfully gain share and accelerate growth over the moderate term as the recovery continues to solidify. As such, we're accelerating investments in technology and other key strategic initiatives across our businesses as we exit 2020 while delivering full year positive operating leverage for the eight consecutive year.
Finally, our credit remains fundamentally sound. We expect full year net charge-offs to be approximately 50 basis points to 55 basis points. This is reflective of the cleanup of the oil and gas portfolio as well as the broader economic conditions.
Now let me turn it back over to Mark, so we can get to your questions.
Operator, we will now take questions. We ask that as a courtesy to your peers, each person ask only one question and one related follow-up, and then if that person has any additional questions, he or she can add themselves back into the queue. Thank you.
[Operator Instructions] Our first question comes from the line of Scott Siefers with Piper Sandler. Please proceed with your question.
I think you guys actually answered a lot of my questions on the sort of the potential for commercial to - kind of resume some growth. So I certainly appreciate that. I wanted to ask specifically on the dealer business, that's been kind of a headwind and kind of is not necessarily huge for you guys?
But was just curious to hear about your thoughts on sort of any window and as to how quickly we should expect that dealer business in particular to recover. In other words, how much of a growth driver can it end up being?
Scott, it's Rich, I'll take that. We've seen really low utilization rates across the dealer floor plan portfolio, what has been typically in the 75% range are now down below 50%. The challenge with that business is just getting inventory back on the lots and while the OEMs are ramping up deliveries to the dealers, new car levels are continuing at pretty low levels. So, we would expect that we would see a steady build from that 50% up towards the end of the year.
And provide a gradual build over the year. This isn't something that's going to ramp up very quickly, but it is going to be something that we see steady state and slowly building throughout the balance of 2020 and into 2021.
And then and Zach, just on the guidance for the full year, and I guess implicit in the fourth quarter. If I'm doing the math correctly, I think the implied NII in the fourth quarter would be up fairly significantly from the third quarter, it sounds like margin sort of flattish. I guess just what are the puts and takes that you see for NII in particular in the fourth quarter?
Sure yes, thanks again for the question. So, I think our outlook for loans sequentially is up in total about 1% or $800 million. We are expecting our kind of baseline underlying forecast is a couple basis points of incremental NIM as we go into Q4. And so that's really going to drive spread revenues up around $30 million. To be clear, it does not include any PPP acceleration, there could be, some revenues come through from that, but we're not banking on that.
Okay, perfect. And it's - not baked in, so that was the following so, all right terrific. Thank you very much.
You're welcome.
Our next question comes from the line of Jon Arfstrom with RBC Capital Markets. Please proceed with your question.
Question for either Rich or Zach on the provision, can you talk about some of the provision drivers for the quarter and what you want the overall message to be as we look forward on that. It seems like some of this was growth driven as well, but can you just talk about provision drivers and expectations?
Sure Jon, it's Rich, I'll start with that. Yes as you pointed out, we did have a relatively modest reserve build in Q3, it was about 3% from Q2. The coverage ratio moved up four basis points from 227 basis points to 231 basis points. I would first point out that we did have over $1 billion in point-to-point loan growth in Q3 which accounted for about 25% of that reserve build. Clearly with CECL, you are taking a life of loan approach to any - loss about to any portfolio build that you have.
But I would tie the build really to ongoing uncertainty with respect to both the virus and the type of stimulus if any that's coming our way. We are seeing COVID cases increasing across much of our footprint, and while we don't expect a return to full stay at home orders. We do believe that is going to be a drag on the economy going forward. And with respect to stimulus, we can see that there is a deadlock right now and the timing and the makeup of what that stimulus ends up looking like is going to be important to the recovery.
I think you have to keep in mind too that all of the economic scenarios have assumptions with respect to both the dollar amount and the timing of stimulus. And to the extent that - that stimulus is delayed or isn't earmarked for where the model thinks it's going. It's going to have also an impact. So when we look at factoring all of that in, the uncertainty that's what really drove us to keep the reserve about where it was, I think at four basis points is pretty much a plateau for the quarter. Those were the big drivers.
But the message, I hear is adequately reserved for what you see today. I have heard that a couple of months. Is that fair?
That's - absolutely.
And then just one small one, it's kind of, it's the noise in your numbers at this point, but quarter your non-performers, about half the charge-offs for oil and gas? Zach you use the term cleanup, what's left there and what's kind of the timing on that?
Yes, I think we just have - we sold $127 million in the third quarter. We've got that portfolio down 50% from where it was a year ago. When we talk about clean up, the book right now is that the point where with the reserves that we have, we will be opportunistic sellers. I think over the course of the last several quarters, there was more of a desire to get the overall numbers down and the pricing that we were able to get allowed us to do that within the coverage ratio that we had.
I don't believe in the fourth quarter that we're going to be aggressive sellers. We will certainly look to sell if it makes sense and to the extent that the fall borrowing base redeterminations require additional charge-offs, we will take them. So, we're going to move into what I would consider more of a traditional problem loan management scenario with oil and gas going forward.
Our next question comes from the line of Erika Najarian with Bank of America. Please proceed with your question.
Steve, my first question is for you. Out of all your DFAST participant peers, I think this is probably the first statement we've heard in terms of expectations to increase capital return in 2021 assuming restrictions don't stretch out for too long. And knowing the bank, you've always prioritized dividend, dividend growth and also of course funding your growth. And I'm wondering if that balance shifts a little bit to buybacks in 2021 given where your stock is relative to your return potential?
Thank you, Erika. We do have a relatively high dividend yield compared to the peer group and that will influence at the appropriate time what I believe are Board's decisions. We would be more oriented towards buyback versus a dividend increase. But no decision, we are not at that threshold yet, but the historic guidance we would have provided will substitute - will likely substitute other uses of capital as a second alternative.
And that dividend is balance with that. Historically, I would say core growth dividend and other uses you'll see a much more balanced approach. Certainly with the stock trading at these levels that seems to, make a lot of sense to us, again subject to Fed and other regulatory support.
And my second question is for Zach. I think of course there was some chatter about swap income potentially rolling off and you mentioned in your prepared remarks that there are no looming cliffs. And if I'm doing the back of the envelope math right the derivative book helped net interest income about maybe $19 million to $20 million this quarter, and of course, correct me if I'm wrong?
And I'm wondering as we think about the outlook for 2022 in your well laddered strategy, what is the dollar impact from the derivative portfolio if you could confirm for this quarter and what you expect it to be for 2021?
I hope the dollar - probably would have basis points. In 2020 for the full year, the derivative portfolio is benefiting us by about 22 basis points. Next year, we expect that to rise somewhat, that's several basis points up to 25 basis points. And then it's sort of gradually runs off through 2022, 2023 and 2024. I think 2022 is about 12 basis points to 13 basis points run-off, 2023 is about seven basis points run-off and then 2024 is actually flat.
So there is no massive cliff, there's clearly a drop and a gradual reduction over time, but as I also mentioned in my prepared remarks. We're pulling all the levers of balance sheet optimizations to really offset and drive that and we do have confidence. We'll further in near current levels over the long-term, leveraging three key strategies; funding optimization, asset growth mix and that customer level pricing.
Last thing I'll say just pull back and see if that answers your question. For next year there will likely be a fair amount of quarter-to-quarter volatility driven by PPP loan forgiveness acceleration, we'll see, but we suspect that that will be in the first couple of quarters.
Our next question comes from the line of Ken Usdin with Jefferies. Please proceed with your question.
Following up on the expense side, Zach, you mentioned three to five expense growth in the fourth quarter and I think you said it was mostly investment, just wondering can you help us just understand what were the restructuring costs that were in the third quarter number and also what you're expecting in the fourth quarter number?
Sure. In the third quarter we have $15 million of restructuring costs. In the fourth, we expect that to be kind of around or just less than $5 million. So, it's sort of incremental $10 million benefit quarter-to-quarter within that 3% to 5% expense guide. I would tell you just pulling back that really the investments are essentially entirely driven by that investment growth.
So, the expenses are essentially driven by that investment growth. We see a little bit of continued quarter-to-quarter growth in variable cost just driven by customer activity continuing to rebound out of the COVID lows, but those are the main drivers.
And then so, if I take that then that there's not much restructuring costs in that fourth quarter number, is that kind of the right base to grow off or it is just more of a one-time step up that just get stuff accelerated or in relative to what you expect to spend as you go forward to your prior comments last quarter about the flexibility within the cost save numbers?
Yes, it's a good question and I know where your mind is going. Let me, so, it's a little too early for us to give you kind of a longer-term outlook. We'll do that more fulsomely in the next quarter update when we talk in January. But I think that what you're going to see is this elevated level of investments continuing for a few more quarters, you cannot turn on the dime with this kind of stuff.
So, we're going to, we're ramping up towards the end of this year as we've talked about over time to capture the opportunities that are, we think are present in the recovery and that will sustain for a few more quarters, but the key for us is really if these things drive revenue growth. We have a very focused investment plan, very tied to our strategic growth initiatives and the expectation is we'll start to see the benefits of that flowing through to accelerating revenue growth as we go throughout '21 and certainly into '22.
Okay and then just one underneath that. What's also, I think, Steve mentioned a bunch of this in his prepared remarks, but like how do you go forward and help offset some of that natural inflation from the spending in terms of things you can either see starting to become more efficient in or, as Steve mentioned earlier, you start to rethink some of the branch locations over time, et cetera?
Yes, I mean you saw it tick down, I think that is right there, I think the investments we've got some of which drive shorter-term and more productivity related benefits, others are longer term and customer acquisition and customer relationship deepening related and behind the scenes we just continue to be incredibly rigorous with our non-investments expense program and I think the way I look at expenses is if you've got growth investments and you deny if you drive the return on that, and you've got the rest of the business expenses that we just squeezed perpetually lower. So the items look at are a lot of what you just said.
Our next question comes from the line of David George with Baird. Please proceed with your question.
I had a question just moving to the fee side of things, there was a good rebound this quarter in deposit service charges. I am just kind of curious how you're thinking about that line item in Q4 and then kind of a run rate starting in 2021 obviously given the amount of liquidity that - that is in consumer checking accounts, that's going to put a damper on it, but I would imagine that the spend has gotten better, so that that's obviously driving some of the improvements. So, I'm curious how you're thinking about that?
Yes, this is Zach, I will take that and perhaps others may want to weigh in as well. So, we did see a bit of a snapback in personal service charges in Q3 by $15 million higher, although it was - continues to run a fair amount lower than last year. As we look forward in the future, I don't expect a lot of growth in that line. I think that the, particularly the elevated levels of deposits that we've seen, I for one believe is they are going to be quite sticky for some time.
I think it's fundamentally related to peoples' uncertainty about the economy and therefore just protecting themselves with elevated liquidity. Again we've seen kind of a flight to quality and flight to proximity from our customers and leveraging Huntington as a place to hold those deposits. So, I think that's going to hold personal service charges lower for a while. It's really not our focus for growth. We're really driving the value-added fee lines over time.
Our next question comes from the line of Ken Zerbe with Morgan Stanley. Please proceed with your question.
So, one of your peers decided to recently exit indirect auto, can you just talk about the economics of that business and how the economics has changed since the beginning of the pandemic?
Yes, Ken, this is Rich. I'll take a stab at that. We love the indirect auto business. I mean this is a foundation and a core competency that we've had for several years now, and we would grow this business as opposed to exit it. The credit quality performs incredibly well through DFAST, it's our, one of our best performing portfolios. I think if you look at the recent deferral activity that we've had in this book in the post deferral delinquencies, they are excellent and right in line with that.
So from a credit standpoint, we couldn't be happier with the performance of this portfolio over time and we're very enthusiastic about the growth of this business over time. So, we have a contrarian approach and I think it's based on the fact that we've got great dealer relationships we've built up over the years and that is proven out very well. So, Zach, you want to touch on that.
I totally agree with everything Rich has said. This business has incredible risk-adjusted returns, to give you a sense of the yields we're seeing right now, new volumes coming in are 3.5%, so it's sort of constructive and helpful for the NIM trajectory.
It's also relatively short-lived asset, so it helps us continue to play as rates potentially move higher over the longer term and it will allow I would say just - we come into this business new, it's great to see these business lines that Huntington has that are, we've got such a diversification of the business as we got that when something else is weak like commercial that we talked about this other one has been really a real source of strength and growth for us. So, yes, could not say enough about how much we like it.
And then just the second question, you guys talked about seeing growth in commercial later this year. I think you referenced it a few times. Just to be clear, is this specifically a Huntington's specific like issue that you're growing C&I or is this or do you envision the broader industry also growing C&I off a low base?
We haven't. We are not in a position to comment on the industry, but we're looking at our pipeline, what we're making and sharing that comment Ken. We have a pipeline today that's comparable to last year in both business banking and our commercial banking teams and typically fourth quarter is a, is one of our best quarters year in year out. I would expect based on the waiting of that pipeline probability of closing to have pretty good fourth quarter and all indications are positive. What we're, we're hearing from customers is a continuing recovery, remember the Midwest is recovering nicely, particularly the manufacturing sector.
The biggest issue we hear in that regard is they just can't get enough employees. Our jobs numbers for the Midwest are higher than any other region in the country. So, this is a labor issue that's constraining some of the potential on the investment side and maybe holding back some the loan demand. So we're actually reasonably bullish about fourth quarter and beyond.
Our next question comes from the line of John Pancari with Evercore ISI. Please proceed with your question.
Just back on the loan growth topic, on the commercial side, I appreciate the color you just gave in terms of the, in your markets and, and some of the trends, outside of dealer services from an industry perspective, where are you seeing the improving growth dynamics. Is it, is it manufacturing like you just said, is that where you're starting to see demand or is that you're just optimistic of that materializing? Are there other portfolios where you are seeing some momentum begin?
We're clearly seeing it in the manufacturing sector John as I mentioned, but it's more broadly based. There is a level of business activity that's occurring on the buyout side, on generational transfers, beyond that there is activity that we're, we're, remember we're principally a lower-middle market bank in the commercial side and as inventories are getting replenished and revenues rebuilt, there is working capital demand.
We do a lot of equipment finance and asset-based lending as well. We've seen particularly in the asset base side good demand, fourth quarter is generally good for equipment finance, our health care activity is very, very strong as well. So it's - it's broad based.
Just to talk on this, this is Zach, as an indication of that, the pipelines are up to almost the level of last year, just to give you a sense, off considerably lower including during COVID, so, and production during the quarter, during Q3 ramps quite substantially.
Yes. Got it. No, that's helpful, thanks for that added color there. And then on the, on the credit side, just to confirm did you indicate that you're criticized assets are down, did you say 12% in the quarter, and also, could you just talk about what areas that you saw improvement and if you think that decline can continue where do you think there's is going to be some pressure to the upside as some of the pressure on borrowers as they come off forbearance and uncertainty on stimulus weighs in?
Yes, 12% was right. It was about $425 million was the reduction over the quarter. It was very wide widespread. We did have the oil and gas sales, which was about $125 million or $127 million, all of that. Just about all that was, was criticized. But beyond that, it was very broad based across just about all of our lines of business, which was heartening to see.
We did do that very comprehensive review in the second quarter, which caused the spike in credit in Q2 and so seeing it come down in Q3, we expected that to some extent and I would say that we will continue to see a downward trend in criticized, it may be a bit lumpy quarter-to-quarter, things will move in, things will move out within different portfolios. I think that's just the kind of the COVID environment that we're dealing and things are going to pop up that might be somewhat unexpected. But I would generally expect our credit quality to begin migrating - the credit class migrating down over time.
Our next question comes from the line of Bill Carcache with Wolfe Research. Please proceed with your question.
Rich, following up on your auto segment comments, it looks like you guys had recently been seeing a growing mix of used car originations, but we saw a mix shift back to new this quarter, I think that was on Slide 44. Can you discuss some of the dynamics there and give us a sense of the relative profitability of new versus used just at a high level?
Yes, I think, this is Zach, I'll start off. [Indiscernible] yield numbers right in front of me, but I think generally this is really influenced by the supply dynamics which I was talking about earlier. So, earlier in the year when the supply interruptions were had on the original equipment side, demand naturally shifted to the - to the used side and so we saw that mix change and I think what you're seeing now is the gradual normalization back to a kind of a longer-term typical mix of new versus used cars. The yield on use is a bit higher than new, but I don't have the numbers right in front of me to comment more specifically, we might be able to follow-up with you on that.
Yes, Bill, I don't have the specific breakout on the yields between new and used, but used is always quite a bit higher than new. And so on a risk adjusted return basis, it's actually slightly better than the new.
Yes, thanks guys and then separately Zach, on your comments around mix optimization and remixing more towards small business in particular. Can you discuss how you guys are thinking about growing into that from - relationship, from a customer relationship standpoint, timing, credit risk perspective, particularly with all the uncertainty around stimulus?
Yes, maybe I'll touch on that a little bit, then Rich maybe attack on as well. I think - and the list of assets we'd like to grow faster, it includes small business but it's not certainly exclusive to that as we noted a lot of others. But I think what we're seeing, our strategy is to really deepen penetration and provide terrific products and experiences to this segment, particularly through the digital investments we're making.
And we're really seeing it works, there is a tremendous demand coming through. I think partly leveraging the real success we have with PPP. And so it's pretty broad-based. I want to Rich to attack on in terms how we're thinking about.
No absolutely the PPP success that we had - certainly the driver of the growth and we are really focused on SBA within small business as a continued lever for growth. We obviously have a core competency in SBA and we will continue to leverage that going forward, but also on the conventional side, business banking which, the non-SBA piece of it, we've seen very good growth as well and that's been pretty widespread across industries, healthcare and others.
Thanks Rich in fact if I could squeeze one last one in for Steve. You guys have done a lot to improve HBAN's ROTCE profile since the great recession. Can you discuss your expectations for the kind of ROTCE generation that we can expect from HBAN to the extent that so were to persist for an extended period?
Well, we haven't changed our long-term metrics on ROTCE at this point. We'll be out as Zach mentioned with an outlook for next year in January. So I think that's fair to use based on the work that we've done looking forward over the next couple of years - as a rough guideline now.
Our next question comes from the line of Steve Alexopoulos with JPMorgan. Please proceed with your question.
This is Janet Lee on for Steve. My first question is on margin obviously lots of moving pieces there, but if I put it altogether, with assets liquidity remaining elevated near term and fixed asset repricing. Looking into 2021 is the direction of NIM modest downward trend from here or do you think you can manage it more stable given hedges benefit?
Yes, good question. Thank you, this is Zach. I'll take that one. So, I think 2020 will likely land around 300 basis points, from just a tick higher and our expectation for 2021 excluding PPP for a second is just a few ticks higher than that. So about flat and my baseline outlook is a few basis points higher, we'll have. I think I mentioned earlier, kind of the next few years, hedge benefits in basis points this year was 22 basis points, next year is 25 basis points, absolutely normal forecast that's up three basis points better.
Interest bearing liabilities I expect to be down also kind of over, around or over 30 basis points. We do expect yield pressure largely offsetting that, so that is sort of flat to a few basis points higher outlook I have got for 2021 at this point. Again, we're continuing to do a fair bit of work around decimals in fact both her guidance later. There are wildcards, there is the PPP timing that I mentioned, there is potentially also some.
We'll continue to look at hedging in the portfolio and that could also throw a few basis points volatility in there, but generally that's my outlook.
And my next question is on operating leverage. So, when we combine with expense savings from the branch consolidations and I guess more bullish outlook on loans going into 4Q. Do you see it increasingly likely that Huntington can achieve positive operating leverage in 2021 again?
No, it's really too early for us to talk about the totality of the full year of 2021. I do expect a lot of the trends that we're seeing right now to kind of continue for the next few quarters just given the momentum and the trend of the businesses that we're seeing right now. And so we'll see, we'll come back and talk more about that. Our commitment around positive operating leverage is a long-term one.
And we think it's the right one for the company, but we're really focused on making the investments now to drive revenue acceleration and I tell you we feel pretty good about it. So, we'll come back and talk more in a few months.
So Steve, we're bullish about coming out of this cycle and taking advantage of it, that has been our orientation in the best and we're continuing with that. So, we'll be looking to drive growth, revenue growth, and you're getting a sense of that off the third quarter earnings.
Our next question comes from the line of Brock Vandervliet with UBS. Please proceed with your question.
Just in terms of lost content in the cadence of net charge-offs going forward. One, I guess how are you feeling about loss content now versus say April, I'm assuming that's better but wanted to ask. And then two, as you look at charge-offs, they've been relatively stable here is there a bit of a catch-up, in other words, an increase from here that we should continue to be aware of or are you anticipating that we can kind of hold at this, more at this level?
Brock, this is Steve, just to go to your April comments, night and day are different, when I think about the volatility and uncertainty in that period of time versus today. So you should be inferring that off the comments about the economy and recovery, et cetera, and that would be true with an expectation of credit quality will mirror the economic recovery. There is still uncertainty and as Rich said it maybe lumpy.
But we don't have a catch-up quarter, we've already caught up. So, we're in good shape as at the end of the third quarter, given the volatility and expect that the team will manage with consistency as we go forward, may be a little lumpy because of the recovery and the nature of it and the virus, but like the footing we have very much.
The mix optimization, could you look to move some of this Fed deposits into investment securities or is that not something you're looking at?
Yes, so this is Zach. It's really not something we're looking at, at this time. We do expect to begin to reinvest our securities cash flow this quarter as we've talked about a little bit over the last few calls and to get back in the securities portfolio to around Q1 levels. So that's about $1.5 billion, $1.6 billion of incremental securities investments in the fourth quarter, but not really with the mind towards utilizing those deposits.
Rather, we are focused on deploying those for core organic growth and to some degree as a funding optimization opportunity that I mentioned earlier. So, that is the plan.
Thank you. Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the floor back to Mr. Steinour for closing comments.
So thank you for the questions and your interest in Huntington. We're very pleased with the third quarter performance and we continue to be optimistic about our future and the economic recovery, but acknowledge volatility uncertainty remain in the economy. Our disciplined enterprise risk management provides a strong fundamental foundation and you're seeing that in our numbers.
We're executing our strategies and will continue to capitalize on opportunities. We're investing - investing in strategic growth initiatives while continuing to deliver solid performance. I'm confident of our ability to manage the challenges we face and excited about our future.
And finally as I thought of reminding you, we are closely aligned of the interests of the Board, executive management and colleagues with the other owners of the company via mechanisms, such as our hold to retirement, equity requirements. And we've collectively been one of the 10 largest shareholders of the company for the past five years.
So, we feel to pay and we're looking forward to a better day ahead. Thank you again for your support and interest in Huntington, have a great day.
Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.