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We have upgraded our recommendation on Huntington Bancshares Inc. (HBAN - Analyst Report) to Neutral from Underperform on the back of fundamentals, better-than-expected first quarter 2011 results, current economic environment and the recent credit trends.

Huntington Bancshares reported first quarter 2011 earnings of 15 cents, beating the Zacks Consensus Estimate of 12 cents. However, after including a one-time addition to litigation reserves, Huntington reported a profit of $126.4 million or 14 cents per share. This compares favorably with $122.9 million or 5 cents per share earned in the prior quarter and $39.7 million or 1 cent in the year-ago quarter.

Huntington’s better-than-expected earnings reflected a significant improvement in credit quality, a modest growth in loans and deposits, increase in net interest margin and low levels of non-interest expenses. However, the company’s top line declined during the quarter.

Huntington remains focused on capitalizing on the growth opportunities. Strategic initiatives are right on track, and the company is poised to benefit from an economic rebound. By making active efforts to reduce its problem assets, the company has lowered the level of its criticized commercial loans.

Huntington is experiencing better credit trends with continued improvement in commercial and industrial charge-offs and some noticeable improvement in consumer charge-offs. The company witnessed a reduction in the inflow of new non-performing as well as criticized assets. Delinquency trends continued to improve. We expect these trends to continue and result in lower credit costs in the upcoming quarters.

Capital ratios also improved in the recent quarters with the company continuing with its profitability trend. We believe that the capital bolstering initiatives, coupled with the company’s proactive measures in strengthening its balance sheet and overall business model, would help it to navigate through the current economic environment.

Yet, we believe that the low rate environment, coupled with limited growth prospects in loans in a tepid economic recovery, somewhat suppresses any substantial improvement in the interest margin in the near term at Huntington. Along with this, the market-related fee income category is also expected to remain restricted in the upcoming quarters. While credit expenses are expected to benefit from low credit costs, continued investments in strategic initiatives are likely to offset such decreases.

In the near term, regulatory issues will remain concerns and the company’s fee income is expected to remain pressured. Though management has taken precautionary measures, the amendment of the Reg E (overdraft legislation) would restrict the company’s revenue from overdraft charges. Additionally, the Dodd-Frank Act and subsequent rule-making will impact the company.

Huntington shares are maintaining a Zacks #3 Rank, which translates into a short-term ‘Hold’ recommendation. However, one of the closest peers of Huntington, Northern Trust Corporation (NTRS - Analyst Report) retains a Zacks #4 Rank, which translates into a short-term ‘Sell’ recommendation.

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