KEYCORP quarterly report, Q2 FY2021

KeyCorp (KEY) — Q2 2021 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2021. Figures are in U.S. dollars; financial statement amounts are generally in millions unless noted. KeyCorp is a bank holding company operating through Consumer Bank and Commercial Bank. The interim financial statements were reviewed by Ernst & Young, not audited.

Financial performance and condition

Metric	Q2 2021	Comparable period / change
GAAP net interest income	$1.017 billion	$1.018 billion in Q2 2020
Noninterest income	$750 million	$692 million in Q2 2020
Total revenue, taxable-equivalent	$1.773 billion	$1.717 billion in Q2 2020
Provision for credit losses	Net benefit of $222 million	$482 million expense in Q2 2020
Noninterest expense	$1.076 billion	$1.013 billion in Q2 2020
Net income attributable to Key	$729 million; diluted EPS $0.73	$187 million; diluted EPS $0.17 in Q2 2020
Net interest margin, taxable-equivalent	2.52%	2.76% in Q2 2020
Net loan charge-offs / average loans	0.09%	0.36% in Q2 2020

For the six months ended June 30, GAAP net income attributable to Key was $1.351 billion, compared with $333 million in 2020; diluted EPS was $1.34 versus $0.29. Taxable-equivalent revenue was $3.523 billion versus $3.183 billion. The six-month provision was a net benefit of $315 million, compared with $841 million expense a year earlier.

Results benefited materially from the credit-reserve release, lower funding costs, and stronger fee income. The Q2 $244 million reserve release was attributed largely to an improved economic outlook. Revenue growth included record investment banking and debt placement activity; the filing also notes that a roughly $20 million recovery related to a prior fraud loss contributed to Q2 credit results.

Balance sheet, capital and liquidity

• At June 30, total assets were $181.1 billion, loans $100.7 billion, deposits $146.1 billion, and long-term debt $13.2 billion. Since December 31, 2020, deposits increased $10.8 billion while loans declined about $455 million.
• Available-for-sale and held-to-maturity securities totaled $40.8 billion, up from $35.2 billion at year-end 2020. The portfolio is primarily agency mortgage-backed securities and related securities.
• Common Equity Tier 1 was 9.9%; Tier 1 risk-based capital was 11.3%; total risk-based capital was 13.2%. KeyBank met the regulatory “well capitalized” thresholds. KeyCorp’s CET1 exceeded its stated 9.0%–9.5% target range.
• Reported liquid assets were $46.4 billion. Additional unused secured borrowing capacity was $21.9 billion at the Federal Reserve Bank of Cleveland and $10.2 billion at the FHLB. The consolidated loan-to-deposit ratio was 70.4%.
• Cash and due from banks was $792 million at quarter-end. Over the first six months, operating cash flow was $248 million, investing cash flow was negative $10.114 billion, financing cash flow was positive $9.567 billion, and cash and due from banks decreased $299 million.
• The quarterly common dividend was $0.185 per share. Key repurchased $300 million of common shares during Q2. In July 2021, the board authorized up to $1.5 billion in additional repurchases through Q3 2022.

Material changes and business trends

• Compared with Q2 2020, net income rose sharply, principally reflecting the swing from a large credit-loss provision to a reserve release, alongside higher noninterest income and substantially lower deposit interest expense.
• Noninterest income increased 8.4% year over year in Q2. Investment banking and debt placement fees rose 39.1%, cards and payments income rose 24.2%, and commercial mortgage servicing fees increased; consumer mortgage income and operating lease income were lower.
• Noninterest expense increased 6.2% in Q2, including higher personnel expense from incentive and stock-based compensation, as well as higher computer-processing costs. The cash efficiency ratio was 59.9%, compared with 57.9% a year earlier.
• Average Q2 loans fell $7.1 billion year over year, largely from lower commercial and industrial line utilization, partly offset by PPP lending and consumer growth. Average deposits rose $16.3 billion.
• Consumer Bank Q2 net income was $259 million, versus $98 million; Commercial Bank net income was $434 million, versus $106 million.
• Allowance for loan and lease losses was $1.220 billion, down $406 million, or 25%, from year-end. Nonperforming loans were $694 million, versus $785 million at year-end; total nonperforming assets were $738 million, versus $937 million.

Outlook, risks and contingencies

• Management reported year-to-date positive operating leverage and said it was on track for positive operating leverage for 2021. Long-term targets include a 54%–56% cash efficiency ratio, net charge-offs of 0.40%–0.60% through a credit cycle, and return on average tangible common equity of 16%–19%. Q2 cash efficiency was above target; Q2 tangible common equity return was 22.34%.
• Management expected net charge-offs to average 20–30 basis points for the remainder of 2021. This near-term outlook was below its through-cycle target range.
• Credit conditions were improving, but management emphasized uncertainty from the continuing COVID-19 pandemic and the expiration of government assistance. Loans that had received COVID hardship relief totaled $3.858 billion; $259 million remained in active relief at quarter-end.
• Key identified risks include commercial and industrial concentration, commercial real estate conditions, borrower defaults, pandemic-related credit and operational effects, interest-rate and market risk, liquidity and funding access, cybersecurity and third-party systems, regulatory compliance, litigation, LIBOR transition, and execution of strategic initiatives.
• Legal proceedings are part of the ordinary course of business. Management did not believe known matters were expected to have a material adverse effect on financial condition, but cautioned that outcomes could exceed reserves and affect results in a particular period.
• Guarantees had maximum potential undiscounted payments of $15.9 billion and recorded liabilities of $142 million; management assessed payment/performance risk as low. The FNMA commercial mortgage recourse program accounted for $6.0 billion of maximum potential payments.
• Interest-rate simulation estimated a 3.66% reduction in net interest income under a gradual 200-basis-point rate decline and a 4.68% increase under a 200-basis-point rise, both within stated tolerance. These model results depend on assumptions and may differ from actual outcomes.

Important facts for investors to verify

• How much of the earnings improvement is sustainable after excluding the unusually large credit-reserve release and the prior-fraud recovery?
• Whether fee-income momentum, especially investment banking and debt placement, persists, and whether expense growth moderates toward management’s efficiency target.
• Whether loan quality and reserve adequacy remain sound as pandemic relief ends, including performance of active relief loans and concentrated commercial exposures.
• Whether capital, liquidity and deposit levels remain strong as stimulus-related balances and elevated liquidity change, and how the new buyback authorization is executed.
• Whether net interest margin stabilizes and actual earnings sensitivity remains consistent with the filing’s interest-rate models.
• Potential developments in legal proceedings, guarantee exposures, regulatory requirements, and the LIBOR-to-alternative-rate transition.