Q3 2023 Huntington Bancshares Inc Earnings Call

Participants

Brendan Lawlor

Richard A. Pohle; EVP & Chief Credit Officer; Huntington Bancshares Incorporated

Stephen D. Steinour; Chairman, President & CEO; Huntington Bancshares Incorporated

Timothy R. Sedabres; Executive VP & Head of IR; Huntington Bancshares Incorporated

Zachary J. Wasserman; CFO & Senior EVP; Huntington Bancshares Incorporated

Ebrahim Huseini Poonawala; MD of United States Equity Research & Head of North American Banks Research; BofA Securities, Research Division

Erika Najarian; Analyst; UBS Investment Bank, Research Division

John G. Pancari; Senior MD & Senior Equity Research Analyst; Evercore ISI Institutional Equities, Research Division

Jon Glenn Arfstrom; MD of Financial Services Equity Research & Analyst; RBC Capital Markets, Research Division

Kenneth Michael Usdin; MD and Senior Equity Research Analyst; Jefferies LLC, Research Division

Manan Gosalia; Equity Analyst; Morgan Stanley, Research Division

Matthew Derek O'Connor; MD in Equity Research; Deutsche Bank AG, Research Division

Robert Scott Siefers; MD & Senior Research Analyst; Piper Sandler & Co., Research Division

Steven A. Alexopoulos; MD and Head of Mid-Cap & Small-Cap Banks; JPMorgan Chase & Co, Research Division

Presentation

Operator

Greetings. Welcome to the Huntington Bancshares Third Quarter Earnings Call. (Operator Instructions). The question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.
At this time, I would now like to turn the conference over to your host, Tim Sedabres, Director of Investor Relations.

Timothy R. Sedabres

Thank you, operator. Welcome, everyone, and good morning. Copies of the slides we will be reviewing today can be found on the Investor Relations section of our website, www.huntington.com. As a reminder, this call is being recorded, and a replay will be available during about 1 hour from the close of the call. Our presenters today are Steve Steinour, Chairman, President and CEO; and Zach Wasserman, Chief Financial Officer. Rich Pohle, Chief Credit Officer; and Brendan Lawlor, Deputy Chief Credit Officer, will join us for the Q&A.
Earnings documents, which include our forward-looking statements disclaimer and non-GAAP information are available on the Investor Relations section of our website. With that, let me now turn it over to Steve.

Stephen D. Steinour

Thanks, Tim. Good morning, everyone, and welcome. Thank you for joining the call today. We're pleased to announce our third quarter results, which Zach will detail later. Our approach to both our colleagues and customers continues to be grounded in our purpose. Our colleagues again demonstrated that we make people's lives better, help businesses thrive and strengthen the communities we serve.
Now on to Slide 4. There are 5 key messages we want to leave you with today. First, Huntington is extraordinarily well positioned to manage through the evolving landscape for banks. The near-term environment includes higher for longer interest rates and uncertain economic outlook expected new capital regulations as well as heightened regulatory requirements. Huntington operates in this dynamic period from a position of substantial strength. Our balance sheet and risk profile were intentionally built over more than a decade, explicitly for these times. Our market position, digital leadership and momentum in core growth strategies put us in the top of the peer set. We intend to lean into this position of strength to drive incremental growth through existing and new capabilities.
Second, we've managed top quartile CET1 inclusive of AOCI. We will continue to drive additional capital expansion for the remainder of this year and over the course of 2024.
Third, we benefit from a cultivated granular deposit franchise and have delivered consistent core deposit growth. Our balanced deposit base forms the foundation of our robust liquidity framework and has been a driving factor in our well-managed beta over the rate cycle to date.
Fourth, credit quality remains strong across our portfolios, driven by our disciplined customer selection, underwriting and rigorous portfolio management. This approach is unwavering, starting with our tone at the top as we maintain our aggregate moderate to low risk appetite.
Finally, we remain intently focused on our core strategy. We are executing with discipline while expanding with existing and new capabilities to support our long-term growth. And very importantly, we are remaining steadfast in our commitment to drive operating efficiency over time. With continued execution of proactive expense management programs, we expect the level of uncertainty in the near term and some level of higher expenses to manage through the realities of the current operating environment. However, these investments will also be accompanied by sustained revenue growth and the net result will be a Huntington that continues to be a strong regional bank with significant growth opportunities ahead.
I will move us on to Slide 5 to further illustrate our position of strength. Our adjusted CET1 ratio is strong and near the top of the peer group. We intend to drive this ratio higher throughout this year and 2024. This plan extends our position of strength, supports continued execution of core growth strategies and puts us well ahead of the proposed Basel III end game and other requirements. Deposit growth has also outperformed our peers by nearly 10 percentage points since the end of 2021. We've built one of the most granular deposit bases with a leading insured deposit percentage and we continue to drive the expansion of primary bank customer relationships. Our liquidity is best-in-class for coverage of uninsured deposits, representing nearly twice the level of peers, and we already meet the liquidity coverage ratio on an unmodified basis. Credit metrics are also a differentiator for Huntington with top quartile net charge-offs compared to peers and our credit reserves are top tier.
Our management team has a long track record of disciplined execution. For example, we were recently named the #1 SBA lender nationally for the sixth consecutive year, and we continue to expand the reach of this business and our support of access to capital for small businesses. Interest rates continue on a path towards the higher for longer scenario, which we've been anticipating for some time. As rates remain higher, the potential for economic activity to be negatively impacted has increased. However, thus far in the cycle, overall, our customers are effectively managing through it. We remain highly vigilant and are proactively managing all loan portfolios. Our top-tier credit reserves and expanding capital support our approach to be front-footed to take advantage of opportunities to win new customers and grow our businesses.
Zach, over to you to provide more detail on our financial performance.

Zachary J. Wasserman

Thanks, Steve, and good morning, everyone. Slide 6 provides highlights of our third quarter results. We reported GAAP earnings per common share of $0.35 and adjusted EPS of $0.36. The quarter included $15 million of notable items, which impacted EPS by $0.01 per common share. Return on tangible common equity, or ROTCE, came in at 19.5% for the quarter. Adjusted for notable items, ROTCE was 20%. Further adjusting for AOCI, underlying ROTCE was 15.3%. Average deposits grew during the quarter, increasing by $2.6 billion or 1.8%. Loan balances decreased by $561 million or 0.5% from Q2 driven both by seasonality and our continued optimization.
Net interest income on a dollar basis expanded quarter-over-quarter, driven by a rising net interest margin. We continue to proactively manage expenses and have begun a new set of incremental actions in the third quarter, including branch consolidation, staffing efficiencies and corporate real estate consolidations. These actions coupled with our ongoing long-term efficiency programs as well as the measures we implemented in Q1 of this year will help us drive rigorous baseline expense efficiency while sustaining capacity for investments in the franchise. Credit quality remains strong with net charge-offs of 24 basis points and allowance for credit losses of 1.96%. Return on capital was robust driving capital accretion with reported CET1 now above 10%.
Turning to Slide 7. As I noted, average loan balances decreased 0.5% from Q2, driven primarily by lower commercial loan balances, which decreased by $1.2 billion or 1.7% from the prior quarter. On a year-over-year basis, average loans increased 3.3%, reflective of our intentional optimization efforts. Primary components of the commercial loan change included CRE balances, which declined by $387 million, driven by paydowns. Distribution finance decreased $434 million due to normal seasonality with lower dealer inventory levels in the third quarter before the expected inventory build in the fourth quarter. Asset Finance decreased by $271 million, Auto Floorplan increased by $122 million. All other commercial categories net decreased as we continue to drive optimization towards the highest returns.
In Consumer, growth was led by residential mortgage and RV/Marine, while auto loan balances declined for the quarter. Turning to Slide 8. As noted, we continued to deliver consistent deposit growth in the quarter. Average deposits increased by $2.6 billion or 1.8% from the prior quarter. Turning to Slide 9. We saw sustained growth in deposit balances in the third quarter, including sequential increases during July, August and September. Continuing the trend we have seen previously. Importantly, core deposits represented the entirety of the deposit growth for the quarter, with broker deposits declining quarter-over-quarter.
Turning to Slide 10. Noninterest-bearing mix shift continues to track closely to our forecast with the deceleration of sequential changes that we would expect at this point in the rate cycle. The noninterest-bearing percentage decreased by 120 basis points from the second quarter, and we continue to expect this mix shift to moderate and stabilize during 2024.
On to Slide 11. For the quarter, net interest income increased by $22 million or 1.6% to $1.379 billion, driven by expanded net interest margin. We continued to benefit from our asset sensitivity and the expansion of margins that has occurred throughout the cycle, with net interest income growing at 9% CAGR over the past 2 years. Reconciling the change in NIM from Q2, we saw an increase of 9 basis points on a GAAP basis and an increase of 10 basis points on a core basis, excluding accretion. The drivers of the higher NIM quarter-over-quarter were higher spread net of free funds, lower Fed cash balances versus the prior quarter and higher FHLB stock dividends in the quarter. Interest rates rose during the quarter, particularly at the longer end. And as we expected, that drove a net benefit to NIM.
In addition, our optimization efforts across both loan growth and funding mix continue to perform very well. These factors resulted in the margin coming in better than we had expected when we shared our outlook in July. We continue to analyze multiple potential interest rate scenarios. The basis of our planning and guidance continues to be a central set of those scenarios that is bounded on the low end by the forward yield curve. And at the high end, by a scenario that projects rates they higher for longer. The higher for longer scenario today assumes 1 additional rate increase in 2023, flat Fed funds through October of '24 and ends 2024 approximately 75 basis points higher than the forward curve.
With the move in rates higher, we now anticipate net interest margin for the fourth quarter to be around 305 to 310 basis points. This is 5 to 10 basis points higher than the level we shared previously. Looking further out, our modeling continues to indicate 2024 NIM trending flat to higher from the Q4 '23 end point.
Turning to Slide 12. Our cumulative deposit beta through Q3 was 37%, up 5 percentage points from the prior quarter, tracking closely to our expectations. Sequential increases in beta are slowing quarter-over-quarter as we have forecasted as the interest rate cycle nears or hits its peak. As we have noted in the past, where beta ultimately tops out will be a function of the end game for the rate cycle in terms of the level and timing of the peak, the duration of any extended pause before a decrease. Given the outlooks for possibly a higher peak and very likely a more extended pause than was the case 3 months ago, our current outlook for deposit beta is to trend a few percentage points higher than our prior guidance of 40%. We will have to see how the rate environment plays out into 2024 to know with certainty. What is critical in our view is to ensure we continue to manage both deposit and loan pricing exceptionally rigorously, drive asset yields higher, deliver solid incremental returns and deliver a better overall NIM from the higher for longer rate environment as a result.
Turning to Slide 13 and expanding on my point on loan yields. The construct of our balance sheet is approximately half fully variable rate, 10% indirect auto, which is a shorter approximately 2-year duration fixed product, 10% in arms with a 5-year duration and the remainder of approximately 30% is longer durated fixed. This mix contributes to the asset sensitivity of our overall balance sheet and has helped us to benefit significantly from the current rate cycle. We are seeing solid increases in fixed asset portfolio yields. Given the higher for longer rate environment, we expect to continue to benefit from this fixed asset repricing going forward, supporting the higher NIM outlook.
Turning to Slide 14. Our level of cash and securities was down slightly from the prior quarter as we lowered some of the elevated cash we've been holding in Q2. During Q3, we did not reinvest securities cash flows and the securities balance moved modestly lower as proceeds were held in cash, given the attractive short-term rates. We're managing the duration of the portfolio lower, continuing our management approach since 2021.
Turning to Slide 15. Our contingent and available liquidity continues to be robust at $91 billion and has grown quarter-over-quarter. At quarter end, this pool of available liquidity represented 204% of total uninsured deposits, a peer-leading coverage.
Turning to Slide 16. We continue to be dynamic in adding to our hedging program during the quarter. Our objectives remain twofold, to protect capital in up rate scenarios and to protect NIM in down rate scenarios. The most substantive increase was in addition to our forward starting pay fix swaption strategy, which increased by $5.9 billion during the quarter to $15.5 billion total. This program is intended to protect capital from tail risk in substantive up rate scenarios and once again benefited us as rates moved higher in the quarter. We also added $2 billion in collars to support our NIM against longer-term down rate scenarios.
Moving on to Slide 17. GAAP noninterest income increased by $14 million or 2.8% to $509 million for the third quarter. Excluding the mark-to-market on the pay fix swaptions, fees were relatively stable quarter-over-quarter. On an underlying basis compared to the second quarter, we saw increases in deposit service charges, including higher payment-related treasury management fees. This growth was largely offset by lower capital markets fees.
Moving on to Slide 18. We're seeing encouraging and sustained underlying trends across our 3 areas of strategic focus for fee revenue growth. Capital Markets, which has grown by a 19% CAGR over the past 6 years, benefits from a broad set of capabilities bolstered by Capstone. While 2023 has certainly been a challenging environment for capital markets activities in both advisory and several credit-driven products, forward pipelines within advisory are solid and we continue to foresee this as a primary contributor to fee revenue growth over the moderate term. Our payments businesses represent one of the biggest opportunities for both relationship deepening and revenue growth across both treasury management and card categories.
In Wealth Management, we see a great opportunity to increase the penetration of the offering across our customers, leveraging our #1 ranking for trust as we grow advisory relationships and drive higher managed assets with recurring revenue streams.
Moving on to Slide 19 on expenses. GAAP noninterest expense increased by $40 million and underlying core expenses increased by $25 million. As I mentioned, we incurred $15 million of notable item expenses related to the staffing efficiency program and corporate real estate consolidations. Excluding these items, core expense growth compared to the prior quarter was driven by higher personnel, occupancy, professional services and a set of smaller items within all other expenses. We have taken proactive actions throughout the year to support the low level of core underlying expense growth we have delivered.
In the first half of the year, we executed on the voluntary retirement program, organizational realignment moving from 4 revenue segments to 2 and 31 branch consolidations. Now in the third quarter, we're taking another set of incremental actions. We are accelerating the implementation of our business process offshoring program, and we're creating efficiencies throughout the organization with the goal of prioritizing resources toward the largest growth opportunities in the near term. We're also driving incremental saves in our corporate real estate footprint as well as implementing another set of branch consolidations with 34 planned closures early next year. These actions demonstrate our commitment to disciplined expense management and will support the continued investment into critical areas of the company to drive long-term value.
As we manage expenses, we're balancing both short-term investment and revenue growth with the longer-term opportunities we know are in front of us.
Slide 20 recaps our capital position. Reported common equity Tier 1 increased to 10.1% and has increased sequentially for 4 quarters. OCI impacts to common equity Tier 1 resulted in an adjusted CET1 ratio of 8%. Our capital management strategy will result in expanding capital while maintaining our top priority to fund high-return loan growth. We're actively managing adjusted CET1 inclusive of AOCI and expect to drive that ratio higher over the course of 2024.
On Slide 21, credit quality continues to perform very well, with normalization of metrics consistent with our expectations. As mentioned, net charge-offs were 24 basis points for the quarter and while higher than last quarter by 8 basis points, are tracking to our guidance for full year net charge-offs between 20 and 30 basis points. This level continues to be at the low end of our target through the cycle range for net charge-offs of 25 to 45 basis points. As previously guided, given ongoing normalization, nonperforming assets increased from the previous quarter and the criticized asset ratio increased with risk rating changes within commercial real estate being the largest component. Allowance for credit losses is higher by 3 basis points to 1.96% of total loans, and our ACL coverage ratio is amongst the highest in our peer group.
Let's turn to our outlook for the fourth quarter on Slide 22. We forecast loan growth of approximately 1% in the fourth quarter, which will put full year loan growth at approximately 5%, matching the lower end of our prior range. Deposits are likewise expected to grow in the fourth quarter by approximately 1%. Core net interest income for the fourth quarter is expected to decline between 4% and 5% from Q3 before expanding throughout 2024 from that level. Noninterest income on a core underlying basis is expected to be relatively stable. Expenses are expected to increase between 4% and 5% into the fourth quarter, primarily driven by revenue-related expenses associated with the expected growth in capital markets, a seasonal increase in medical claims and sustained investment in new and enhanced capabilities. We expect net charge-offs for the full year to be near the midpoint of the 20 to 30 basis points guidance range.
Finally, let me close on Slide 23 with a few thoughts on our management priorities for 2024. We're still finalizing our budget for next year. And as always, we look to share more specific guidance during our January earnings call. First and foremost, we're committed to driving continued capital expansion while we continue to optimize lending growth to drive the highest returns. As Steve mentioned, we're playing from a position of strength, and we expect to maintain that position as we get ahead of proposed capital regulations and phase-in periods.
Related to deposits, we're continuing to acquire and deepen primary bank customer relationships. This should result in continued growth of deposits into next year, while supporting our disciplined management of deposit beta. Given the expected higher for longer rate scenario, we will continue to position the balance sheet to remain modestly asset sensitive, which will support the margin, and we expect will deliver both in net interest income dollars on a full year basis. Noninterest income remains a critical focus for us with sustained execution on 3 primary strategic areas for fee revenue growth; capital markets, payments and wealth management.
Over the medium term, we expect that noninterest income has the potential to grow at a rate more quickly than both loans and spread revenues given the opportunities for these fee businesses. As I mentioned on expenses, we have taken considerable actions to hold baseline expense growth to a low level. This focused on sustained efficiencies, including operation accelerate, business process offshoring and the other actions will yield multiyear benefits. These actions are necessary to allow for the continued investment into new and enhanced capabilities, which will set up growth over the course of the next few years. We expect the net result of these actions for 2024 will be an underlying growth rate of core expenses, somewhat higher than the level we saw in 2023.
Our current working estimate is underlying expense growth of approximately 4% compared to the approximately 2.5% level we were running in 2023. We believe this level of expense management is the right balance to position the company to operate within the current environment and sustain our momentum into 2025. We will also maintain our rigorous approach to credit management, consistent with our aggregate moderate to low risk appetite.
Finally, to close, we believe we are exceptionally well positioned to proactively stay ahead of the evolving environment. We will be dynamic and address these numerous topics head on. And over time, we believe this will result in opportunities to benefit substantially in the coming years.
With that, we will conclude our prepared remarks and move to Q&A. Tim, over to you.

Timothy R. Sedabres

Thanks, Zach. Operator, we will now take questions. We ask that as a courtesy to your peers, each person ask only 1 question and 1 related follow-up. And then if that person has additional questions, he or she can add themselves back into the queue. Thank you.

Question and Answer Session

Operator

(Operator Instructions) And our first question is from the line of Manan Gosalia with Morgan Stanley.

Manan Gosalia

Can you talk about the puts and takes in that 4% expense growth number for next year? What sort of revenue environment does that bake in? Are -- what are the areas that are pushing up expenses and maybe also where you have flexibility to manage more if the revenue environment is weaker?

Zachary J. Wasserman

Yes. Great question. And this is Zach. I'll take that one. Just to (inaudible) and set a framework for the answer, let me reiterate what I said in the prepared remarks a minute ago, which is driving efficiency in our core expenses is a key priority for us. We're one of the most efficient banks in the regional banking space, and that's been a product of years of efforts. What we're trying to do right now is strike a balance of the short term and the medium term.
In the short term, managing expenses to a low level of growth given the overall revenue environment. But also in the medium term, we see significant growth opportunities over time for Huntington, and we want to make sure that we maintain the momentum in our key strategies and, in fact, capture the higher revenue outlook that we even just shared. Even as we quickly get ahead, and I stress that work quickly, get ahead of the new and expanded risk management capability that we'll need to operate. If you take a step back, it's just over a year ago, that we were fully delivering of over $0.5 billion of annual expense saves from the TCF merger.
Over the last year since then, we felt underlying core expenses to 2.4%. And we did that with all of the programs I've just talked about in the prepared remarks, the long-term efficiency programs, the proactive actions we took in the first quarter of this year and now a new set of actions that we're implementing in the third quarter, including another tranche of branch optimization, accelerating the business process offshoring, driving efficiencies across the bank and finding efficiencies in our corporate real estate portfolio.
As we look at the '24, to your question, we're seeing the opportunity for incremental revenue upside, particularly in the really strong performance we've seen in our NIM management program, which is higher than our prior outlook and good momentum in the fee businesses as we look forward. We want to quickly address the lessons learned on the last use environment, address the new regulations coming around Basel, CCAR, resolution planning and ultimately enhance our risk management so we can operate in -- from a position of strength, just as we are right now, going forward, which will require investment. So the kind of things that are driving that roughly 1.5% higher run rate, our investment into teams like treasury, risk management, technology, it's with a focus on enhancing data, underlying process capabilities and automation.
The goal in India, well, take a step back, is to get ahead of these requirements to quickly move through this period. We expect to see around a year's worth of this higher expected run rate expenses to be around 1.5% higher and then that expense growth rate will come back down again as we exit 2024, and we'll see the underlying core expense management come through. It all goes back to the goal of maintaining our (inaudible), our momentum and really ensuring that Huntington continues to be in a position of strength to go forward.

Stephen D. Steinour

Manan, this is Steve. Just to sort of come in over the top of that. We think this is the time to be dynamic to play off us to be front-footed in terms of a number of our businesses, and we intend to do that, and that will require investment. We'll have more colleagues, more talent, if you will. We'll have some new capabilities, all of which are in the plan and the numbers Zach shared with you.

Manan Gosalia

Got it. And then just putting it together because you mentioned you're modeling NII trends higher as you go through 2024, there's more upside to fees. How does that play into operating leverage for next year? Do you still think you can drive positive operating leverage?

Zachary J. Wasserman

It's a little (inaudible) give you precise guidance on that, but driving toward operating leverage over time is a key element of our goals. You'll remember that it's 1 of the 3 major financial targets we set for ourselves. And we do see solid opportunity for revenue growth next year on both spread and fees. But I would just again coming back, what's critical for us is managing for the medium term at this point. And we want to make sure that we can maintain those critical investments even as we're driving the efficiencies in the underlying expense growth rate. Talk about operating leverage over time, we'll have some part of the plan, and we'll have to see the precise outlook for '24 (inaudible).

Operator

Our next question is from the line of John Pancari with Evercore ISI.

John G. Pancari

Just on the net interest income front. I know you indicated that you implied -- you expect a trough in the fourth quarter and then expanding through 2024. Maybe can you help us frame the magnitude of growth that you think is achievable under the current curve assumption as you look at the NII upside? And then I guess the same question would be for your commentary around the margin in terms of expansion through the year? Maybe if you can help us size that up in terms of what's a fair assumption based on what you're looking at?

Zachary J. Wasserman

Yes. That's a great question. This is Zach. I'll take that one. I think just take a step back, and you saw in the third quarter, really highlighted the effectiveness of our overall asset sensitivity management program, where we saw NIM expand and the benefits of asset repricing really coming through into a stronger NIM. What we saw in the third quarter was about 10 basis points increase in NIM from the second quarter. Around half of that, I will note are items that were temporary in nature, reducing Fed cash in Q3 from Q2 drove around 3 basis points. We've got some elevated levels of dividend from the FHLB stock that was a function of Q2 FHLB borrowing, those items won't recur.
However, we did see a positive 4 basis point move in underlying spread in the third quarter as I noted. As we think about Q4, our expectation is that to see a NIM of between 305 and 310 basis points, which is around 5 or 10 basis points better than I would have thought this time last quarter. And it's really driven by the benefits we're seeing coming through from the higher for longer rate scenario, which as we've noted, we would expect to be accretive to overall NIM, and that is bearing through. Based on the trends we're seeing in earning assets, I expect the dollars of NII in Q4 down around 4% to 5% from Q3 and forming a trough both in NIM ratio and the NIM and net interest income dollars in the fourth quarter then trending higher from there.
The NIM outlook for 2024, I expect to be flat to rising, as I noted. And I think the things you're going to see are continued really solid progress on fixed asset repricing, major asset categories on the fixed side this quarter are seeing again, sequential increases into Q3. We'll expect to see that continuing on particularly in the higher for longer scenario. Even as we do see beta continuing to trend as well. It will be accretive to the overall spend throughout the course of next year we think. Will also benefit, as we've noted before, during 2024 from a gradual reduction in the negative carry from the received fixed swap hedge portfolio, we estimate roughly 5 basis points throughout the course of next year on that benefit, but mainly in the second half of the year.
So I would say couple that flat to rising NIM with growth in loans, growth in earning assets that, as I know will drive overall NII dollars higher. We'll get more precise with guidance as we get into January. But those are the major drivers that we're seeing at this point.

John G. Pancari

Very helpful, Zach. And then separately on credit. Criticized loans up 17% linked quarter. It looks like -- and I believe you alluded to in your comments, a lot of that was commercial real estate. Can you -- and I know you added to your reserve and commercial real estate nonperformers are also up pretty sharply. Was there a dedicated effort to scrub the portfolio that you're working through your exposures there that drove a lumpier move here? Or is this the deterioration that's starting to take shape as we all expect in this sector?

Richard A. Pohle

John, it's Rich. Let me start with that, and then I can turn it over to Brendan to give you a little bit more color on what happened in the third quarter. So if you think back to Q2, our NPA level was at 46 basis points, which was the lowest level we've had since the GFC, and we've had 8 consecutive quarters of declines, totaling over $450 million since then. The Q3 level that we're at today, 52 basis points is right around where we were this time last year. So to me, it's not at a level that's concerning to your point around being proactive. We have done a lot of the adds to nonaccrual that we had in the quarter were discretionary. We think about 2/3 of our commercial NPLs are current on their principal and interest. The [critical asset] is a similar story. We had reductions in 5 of the 6 previous quarters. And as you talk about credit normalizing, you would expect to see an increase in critical asset from that.
So I wouldn't categorize the movements as huge jumps. I think it's just a normalization at very low levels for us. But Brendan, why don't you give a little bit of insight into the Q3 specifics.

Brendan Lawlor

Sure. Thanks, Rich. To provide just a little bit more color, approximately -- for critical asset, approximately 60% of the increase was focused in commercial real estate and our ABL group. There are 2 places you'd expect to see higher levels. On the NPA side, it was split more equally between commercial real estate and C&I. For both NPA and critical asset, as you noted, the real estate exposure was focused mostly in office. And on the C&I side, beyond the ABL concentration I mentioned, there really weren't material concentration. So I think what you're seeing in the numbers, as Rich said, it's just a bounce off a very low bottom.

Operator

Our next question comes from the line of Ebrahim Poonawala with Bank of America.

Ebrahim Huseini Poonawala

Just maybe a question for you, Steve. I think -- I mean, you all have talked about being front-footed, there are banks that are talking about coming back to loan growth next year. But I'm just wondering if there's going to be a ton of loan demand to speak of for banks to lend into. Just give us a sense of what you're seeing across your footprint, where that loan demand is coming from? Or are you seeing customers get increasingly cautious?

Stephen D. Steinour

Ebrahim, great question. Thank you. I believe there's a growing cautiousness. What's going on in Israel and the Middle East, what's going on in Washington. We've got a UAW strike that does not have an apparent resolution. And I think businesses are reacting to that. 99% of our customer base, probably the companies, rates are up. They're using their liquidity, but the uncertain economic outlook and where rates are going, all sort of are headwinds to the next round of growth.
Having said that, our businesses are doing well. We'll have good growth. We'll be within guidance that we gave you -- that Zach gave you earlier in the year, will be up about 5% year-over-year. And we'll continue to see growth next year, I believe, in a couple of areas in particular. Our distribution finance is a powerful engine. It seasonally reduced this quarter. It will be up in the fourth quarter, and we expect to continue to grow that by winning new business. We are a significant equipment finance lender. And more and more onshoring, more automation, there'll be continued demand, albeit probably not at the levels we saw in '22 and before. That will play well. And we're top 10 asset-based lender. So all of those asset related finance activities should do well in this environment. And as you know, we are a huge small business bank. The small businesses will need more support and we'll be there for them. And those will be sources of growth. But there's an overall more cautious outlook within our customer base, just that will have some moderate impact on, I think, on overall loan demand next year.

Ebrahim Huseini Poonawala

Got it. That's helpful. And I guess a follow-up. Zach, you mentioned solid increases in fixed asset portfolio yield at they repriced. Just talk to us in terms of when these are coming up for repricing? Is it just kind of playing out contractually, if there's some negotiation in terms of the spreads narrowing at the time of repricing of these fixed rate loans? And is that kind of impacting credit [sense], are some of these borrowers looking a bit worse in terms of their ability to service the debt post repricing?

Zachary J. Wasserman

Yes. Great questions, and let me address those. So what I'd say is in terms of the trajectory on asset yield, take it back, over 200 basis points through the cycle to date, and it's really been a couple of things, most notably an intentional outcome that we've had in terms of how we're incrementally driving new loan production into -- and really driving for higher returns, which also is often higher NIM. So we're seeing that come through in a lot of the areas where we're actively modulating and optimizing Indirect Auto, for example, is a great example that with fields up tremendously on the (inaudible) the course of the cycle.
It's also though just a natural outcome of the structure of the balance sheet. And one of the reasons why we added the slide we did this quarter in terms of detail there was to just provide more transparency into that. We're around 50% fully variable. So you're seeing benefits of higher rates come through on that portfolio. Another roughly 10% in shorter durated fixed Indirect Auto. As I just noted, we're seeing really sizable increases in portfolio yield there. Another 10% in arms of a 5-year duration, which we're gradually seeing that come through in the higher for longer scenario, every one of those fixed asset categories, including the longer durated remaining third of the portfolio are really paying the benefit and we've seen just in Q3, 50 basis points increase in the new coupon yields across the portfolio, greater than 20 basis point increase in back book portfolio yields.
And I do think that will continue to trend here, and one of the key drivers for NIM stability and growth as we go into 2024. We're not seeing any substantive portfolio-wide credit-driven yield repricing substance and really, it's much more fundamentally driven as I noted.

Stephen D. Steinour

Ebrahim, just to add, we've got a very diversified portfolio. We've been very disciplined with our aggregate moderate to low risk appetite over the years, you've seen us report quarterly since 2010 in the consumer book, which is Super-prime, (inaudible), Auto and Resi, et cetera. So we're sitting in a position we feel the strength, we have confidence in the portfolio and our ability to manage through even in a tougher cycle. And as we've said to our customer base, we've got a relationship orientation. We're here to support them, and we will -- we're in a position to do that with our reserves, our capital, our robust liquidity and that leads us to this stance on playing offense and moving share during these next couple of years.

Operator

Our next questions are from the line of Scott Siefers with Piper Sandler.

Robert Scott Siefers

Zach, I just wanted to clarify if I heard correctly just on the NII. Are we expecting it to grow full year '23 -- pardon me, full year '24 over '23 or just positively off the fourth quarter base?

Zachary J. Wasserman

Well, Scott, great questions. (inaudible) clarify both. So to see trajectory of growth (inaudible) year and on a net basis, full year growth as well, which is going to be a function of flat to rising NIMs and pretty compatible overall full year and year-on-year as well as growth in earning assets and loans.

Robert Scott Siefers

Okay. Perfect. And then I wanted to kind of revisit the cost equation a bit. Maybe on the initiatives that you began in the third quarter, maybe just some thoughts on how substantial they are? And I guess ultimately -- I guess the question becomes -- we'll have about 4% expense growth despite these initiatives sort of begs what cost growth might have been without them. So just any sort of further thoughts on exactly where we're investing, what this will ultimately end up driving et cetera?

Zachary J. Wasserman

Yes, terrific question. (inaudible) to expand on that. If I think about the equation that we were managing in 2023, we've been seeing around 2%, 2.5% underlying expense growth. And that's with the benefit of significant efficiencies that we're generating this year. I estimate that around 1% benefit in expenses in 2023 from these cumulative initiatives running for the last [6 to 18] months and self-funding underlying investments. We've talked about this model before driving efficiencies in the core, keeping the underlying core at a low level with the funnel and outsized level of investment and expense growth into key investment earnings like tech, marketing, new additions of personnel to support your strategies, those underlying investments are up almost 20% in 2023, which is what we will hold the competitive capabilities that we thought.
As we go into (inaudible) that model is what drove the overall roughly 2.5% growth that we saw in '23. I think what we're seeing as we go into 2024 is roughly similar sort of underlying expense management program, really modeling down somewhat the underlying investments in light of the environment, clearly, but also bearing some modest incremental impacts of just the cumulative inflationary environment and the efficiencies will rise as well. And so the net kind of underlying run rate that I would have expected into next year is around 2.5%.
And then on top of that, we are accelerating again, these investments in regulatory response, risk management capabilities that represents the additional 1.5% expense growth as we go into next year. That's the 4% trajectory. If I think about where we're investing is to talk on this briefly, we continue to focus on core strategy investments, delivering the TCF revenue synergies, growing our commercial bank through vertical specialized -- specialty expertise, digital and product development in our Consumer Banking and Business Banking division continue to drive the fee revenue strategies and capital markets, payments and wealth and then on top of that, clearly dealing with these additional areas around Basel III, CCAR, liquidity and interest rate risk management, resolution planning and data and automation.

Stephen D. Steinour

This is Steve. Just to add on. You'll also see several new initiatives that are also included in that number of 4% that we'll be announcing Q4 and Q1.

Robert Scott Siefers

Okay. Perfect. And I guess just one final ticky-tack question. The fourth quarter cost increase, will that include any unusual charges the way we saw this quarter?

Zachary J. Wasserman

So we saw around $15 million of onetime costs this quarter. Some portion of the onetime costs that we expect to arise as a result of the new initiatives were taking place, we're not able to be accounted for within the third quarter. I'm expecting roughly $10 million additional onetime expenses in the fourth quarter related to those same initiatives. That's not included in the guidance that I gave earlier relatively (inaudible) scheme of things. So the total one-timers related to those actions, I expect to be approximately $25 million in total, which, again, we've taken $15 million into the P&L in Q3.

Operator

Our next question is from the line of Matt O'Connor with Deutsche Bank.

Matthew Derek O'Connor

So just circling back on capital, obviously, strong, really any ratio you look at including AOCI and I understand the logic of building capital from here given uncertain macro and you're kind of lean in the business. But is there a level that you're like once we get here, it's just more than we need under almost any scenario, and you'd look to deploy it more aggressively?

Zachary J. Wasserman

Yes. It's a great question. Let me take a minute to expand on that. As you know, driving capital higher from here is a key focus. We have fully transitioned within the company to managing the primary metric of adjusted CET1, inclusive of AOCI. And on that basis, we're at 8% in the third quarter, our operating range for CET1 is between 9% to 10%. And so we want to drive that 8% ratio up into that operating range of between 9% and 10%, and that's the key goal.
I think by the time we get there, I expect that we'll work with significant confidence in being able to do that, by the way, over time. By the time we get there, presumably we'll have clarity around the final Basel III requirements any other implications to capital coming out of the new regulatory environment. And we'll be able to also reassess where the macro environment is and where the lending trajectory as I alluded to the question we got earlier. And so hard to tell sort of exactly where within that range we want to go. But my expectation is once we get into that range, but we have opportunity to get back to a more normalized capital distribution model, support elevated and longer-term run rate levels of loan growth that we've seen in the past and move through it.
I'll just tack on our current working hypothesis and modeling estimate around the Basel III proposal, if it was adopted exactly as was proposed just roughly 5% increase in RWA based on the phase-in schedule that was proposed as part of the NPR that wouldn't be phased in until 2027, and we represent about 40 bps of CET1 in 2027 as that proposal is written. And so part of this is just quickly get ahead of that, you get so far out of time (inaudible) and allow us to really move forward on our front foot starting '25 and beyond from an accelerated loan growth perspective.

Matthew Derek O'Connor

Got it. That was helpful. And then just quickly squeeze in the mark-to-market impact of the pay fixed swaptions, maybe it's a silly question, but do we just kind of put in some gains when rates go up and then if rates go the other way, is it mark-to-market on the negative side? Or how should we think about modeling that and the drivers?

Zachary J. Wasserman

Yes, let me expand on that, and I'll put (inaudible) is just modeling the question. Just the strategy of those instruments was to protect capital against really substantive up-rate scenarios. When we purchased them, they were roughly 200 basis points out of the money. You got about 9 to 12 months of forward life and they would be designed to protect 1/3 to maybe as much as 45% of the securities value of risk in those really substance about 200 to 300 basis point shock scenarios.
I think the -- we put a lot of them on early in the second quarter. We added to that portfolio earlier in the third quarter. And we see -- we spent roughly $30 million in premium. So in our view, a pretty small insurance policy for a very significant benefit in those shock scenarios. What we've seen thus far is gains. We saw $18 million of gain in Q2, a $33 million of gain in Q3. That's a $51 million cumulative gain. I'll tell you if you were to strike them right now, you see another gain in the fourth quarter, but clearly to get March at the very end of the quarter.
The answer is yes, in the near term. If rates rise, you would see gain in them. If rates fall, you would see a loss in them. The key thought process for us is how critical is that insurance policy to continue to maintain. And so versus the gain in them. If we continue to hold them, I would expect that over time, they would expire unused and out of the money. You'd see that gain run back through as a negative through fee income if they weren't closed out, and we will be dynamic in continuing to watch the interest rate outlook with a primary focus on protection capital. At this point, again, pretty deminimus cash outlay for a really strong insurance policy.

Operator

Our next question is from the line of Ken Usdin with Jefferies.

Kenneth Michael Usdin

Steve, I know you talked about generally a little bit of softening demand out there. But I wanted to ask you on your Auto business, I did notice that your originations were up, and obviously, a lot of peers have pulled away from this business, and it's a business that you guys have been historically very strong in and now has really good incremental yield. Just wondering if that's at all an opportunity set and have you kind of -- how do you think through reengaging there as one of those potential growth engines, especially as you've been able to show the deposit stability?

Stephen D. Steinour

Ken, great question. And Auto has performed very, very well for us. We have confidence in its credit and spreads are very attractive now. It's a cyclical product and in the past, we -- when spreads have widened, we've chosen to do a bit more. We'll be dynamic as we look at this as the interest rate environment clarifies. And it's a short -- it's a relatively short asset. It's roughly a 2-year average duration. So we like this asset class a lot, and we certainly like it counter cyclically. And that will be something we'll be looking at closely as we go into '24 and '25.

Kenneth Michael Usdin

Okay. Great. And then last thing, Zach, just looking at what you moved around a little bit on the swaps portfolios. Can you just kind of walk us through some of your decision trees with regards to this quarter's terminations and locking in here and any anticipated future activity you're thinking about in terms of just the book as it stands going forward?

Zachary J. Wasserman

Absolutely, absolutely. And I will tell you this is a very dynamic and active discussion, it's a meekly pretty rigorous to data and analysis process that we do. And it's always focused on 2 key strategies. Protecting capital against up rate scenarios and protecting NIM against down rate scenarios. As I alluded in the prior question around the pay fixed swaptions, you did add during the quarter to that, anticipating that rates had the strong potential of moving higher and want to protect capital against that and we did and rate (inaudible) as you saw, clearly, and so that benefited us there.
But what's interesting as well is that the curve has steepened, the long end has come up as much as it has the opportunity to optimize and can take incremental down rate hedging opportunities in a more efficient manner with less upfront negative carry is increasing. I would say as it relates to that, our view is still lagging into it, no big bets, and we're seeing very significant benefits just come through in the base asset sensitivity, clearly, but over the longer term, I think kind of to '25, '26, '27, we certainly want to protect those revenue streams and we'll be seeking opportunities to increase down rate hedging here if the environment continues to be what it is.
In the meantime, it's more of an optimization, I would say. You saw us exit some received fixed swaps in Q3. This was mainly a shorter duration, just less efficient structures by updating them and increased capacity to (inaudible) for longer structures. We entered in some collars, which would give us the option for down rate hedging if rates are attractive out of the future. And I do suspect that there'll be more of that down rate hedging opportunity as we go throughout Q4 and into early part of next year if the curve continues to be the way it's shaped now.

Kenneth Michael Usdin

Okay. And is there a way of kind of just putting all that together in terms of like the net impact of the swaps book on your NII and is that getting better going forward or worse? Can you just kind of help us put it in context, if you can?

Zachary J. Wasserman

Yes. That's a great question. So just zooming into '24 for a second, based on the swaps that we've got in the portfolio today, I do expect we're seeing roughly a 15 to 17 basis point drag in currency waiver, it was 15 basis points in Q3, I expect it to be roughly 17 bps of drag in Q4 of 2023 from the overall swaps coming through NIM. As I noted one of the earlier questions in this hour, by 2024, I expect that to reduce by about 5 bps, particularly into the second half of the year when the curve starts to fall in the forecast.
Yes. So that's probably the best way to answer your question. In the end, the goal is to call it a NIM really just to support it in this type of range for years to come.

Operator

Our next question is from the line of Erika Najarian with UBS.

Erika Najarian

My questions have been asked and answered. Thank you.

Operator

Our next question is from the line of Jon Arfstrom with RBC Capital Markets.

Jon Glenn Arfstrom

Rich or Brendan, what's the message you want to send us on the outlook for provision and reserves? I mean it feels like you feel fine on credit, but I'm curious if you feel you need to build reserves and how you want us to think about provision?

Richard A. Pohle

Yes. Let me just start with kind of where we are in the quarter. We bumped up by 3 basis points, our coverage ratio. It was nearly a 1% dollar increase. We went up $26 million, and we put most of that into the commercial real estate reserve just given the uncertainty that we've got there. Where we go from here, I mean, we don't give specific guidance around the coverage ratio, particularly around the provision. But it's going to depend on where the economy goes to the extent that we see further weakening, we'll reevaluate it. But I would imagine that any builds from here would be similar to what you would see in the third quarter, fairly nominal from a dollar standpoint, we might be moving some things around.
But in general, we feel really good about where the reserve is right now. And as we get to the other side of this and the economic outlook starts to improve, I could see us bringing the coverage ratio back down into that 1.60% range over time. So we'll look at it every quarter, Jon, and -- but we feel good about the 1.96% right now.

Jon Glenn Arfstrom

Okay. Late in the call, Steve, but just a bigger picture question for you. You had a good quarter. But when I saw the guide for the fourth quarter for lower NII and higher expenses and then for the expense guide for '24, you kind of pulled back some of that optimism, I guess my bigger -- and I think you understand that. But my bigger picture question is, what's the message for '24? Is that -- is it a year of investment and you're not going to push revenue growth? Or are we just all being a little bit too pessimistic here and just focusing on the expenses and some of the near-term NII headwinds?

Stephen D. Steinour

Zach also talked about improving net interest income and NIM in '24. So I don't think of that as our outlook is not of a negative nature. We're investing in the businesses, we're going to do a number of things that I think will position us really well for the medium term, like '25, '26 in terms of further growth. We'll have some new capabilities and some additional talent in the company. We'll be in a position to manage with data and processes even better as we go forward. We're accelerating some of our multiyear plans into '24. And as Zach said, that's -- that growth outlook for expenses in '25 comes back to a more normal level.
So this is us being intentional, position the company to play OpEx and we think we're in that position. We are confident on our credit. We've got good and growing capital on both the gross and an adjusted basis. Liquidity is exceptional. The deposit growth continues. And as you saw in 2010 to those who were around in that period of time, there are moments to take advantage. That's when we launched Fair Play, that's when we do a number of things in the commercial bank and really opened up SBA lending, et cetera. We think this coming year is one of those moments, and we intend to put (inaudible).

Jon Glenn Arfstrom

Okay. So it's -- okay, that's good. I had to ask it, Steve, I'm getting asked that question, but I just needed to know if you're optimistic or pessimistic for 2024, and it sounds like you're...

Stephen D. Steinour

We are optimistic about '24 and beyond. And beyond, Jon.

Operator

Our final question is from the line of Steven Alexopoulos with JPMorgan.

Steven A. Alexopoulos

Steve, I've heard all the commentary for the past hour on expenses. And I guess what I still don't understand is, is the step-up in expense growth in 2024, is that tied to you seeing a better revenue environment to absorb a higher level of spend or something going on that's going to require you to spend more in 2024 agnostic for the revenue environment?

Stephen D. Steinour

So we're gearing the company to manage a growth dynamic that we expect will be in place in '24 and beyond. We also are accelerating certain multiyear investments into 2024, so we're in an even better position with data, and it's principally data to manage -- in managing company, right? We're at different scale outpost TCF. We saw a lot of unique activity in March around Silicon Valley, things move very quickly. We want and our Board wants better data, better access to information that we have and pushing a button together.
So we're -- we've been on a multiyear journey. We're going to pull that forward and position the company to be even stronger. We've been managing market risk as you've seen with us hedging about half of our AFS portfolio since '19. But our processes have not then as automated as we would like them to be, given the speed at which things can change. And so we said we would take advantage of lessons learned out of Silicon Valley and others in this most recent episode, and that has resulted in us making a number of adjustments in our treasury and outlook policies that I think will prove to further bolster our aggregate moderate to low risk appetite and then these investments in data and some other areas in addition to the revenue area investments, will also position us to more effectively manage the company on a real-time basis.

Steven A. Alexopoulos

And will this step the pace of investment? Is that a 2024 story? Or is it a 2024 and beyond story?

Stephen D. Steinour

But we're trying to pull things forward into '24 as Zach said, and as we think about '25 and beyond, we'll be back to a more normalized. Again, this is -- this was an election (inaudible), an overall view of trying to take advantage of the environment that we see in '24 and beyond and position the bank for growth. I like this what we did in (inaudible).

Steven A. Alexopoulos

Well, it sounds like it's partially opportunistic and partially you need to invest in systems, right? It sounds like that's the portion of this, too.

Stephen D. Steinour

We had multiyear plans that were accelerating. That's choice.

Steven A. Alexopoulos

If I could ask one last question. So I don't know if it was (inaudible) recently was asked about crossing $100 billion. Well, you really don't want to cross organically, right, you don't want to be $101 billion. But you guys had $186 billion today. How do you see this with these proposed changes coming? Do you think you're in a good spot at this asset level? Or do you think you need to boost size and scale to just given what this potentially comes?

Stephen D. Steinour

We own the risk at risk management. We're going to maintain this aggregate moderate to low-risk appetite. We've done things well in the past. We'll continue to do them in the future. I think the size of the business is not the only determinant. I think the business model itself is very, very important. Part of the strategy over time is to be deep in certain markets for our consumer and regional bank, giving us brand awareness and other attributes that let us continue to grow the core. And then we've invested selectively in a variety of commercial businesses.
Our asset finance or equipment finance ABL of distribution finance, a number of these businesses that -- and beyond the specialty businesses that are national in nature, complemented by things that we've added on the payment space last year. The acquisition on the investment banking side, all of which give us more pride and capabilities to strengthen our customer base. And we we're going to continue that. We've alluded to additional talent and capabilities in the near term, and we expect to be in a position to start talking about that. But all of that's in that 4% guidance for you for next year.
Okay. So we're grateful for you joining us today. I just want to compliment Rich (inaudible) one more time because this last year, Rich's got a retirement coming at the end of the year. And Rich has just been a terrific leader. We've greatly benefited from your experiences. Rich, you position us well as you've heard on the call. So thank you very much.
In closing, we're pleased with the third quarter results as we dynamically manage through this environment. We're bearing what we believe we're very well positioned for times such as leased with strong credit quality, improving capital ratios and robust liquidity and is supported by consistent efforts from our 20,000 colleagues across the bank to deliver these results. We are a team, you know this a disciplined operators and we're executing on our strategy that we outlined last year's Investor Day, and we're driving shareholder value. We're optimistic we're going to continue to do that in the years to come. And as a reminder, we're all aligned, the Board executives and our colleagues, our top 10 shareholder collectively, and we feel the (inaudible) of this market pull back. We're very focused on driving consistent strong performance. So thank you for your support and interest in Huntington, and have a great day.

Operator

Ladies and gentlemen, this will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.