KeyCorp (KEY) — Q2 2020 Form 10-Q
Reporting period: Quarter ended June 30, 2020; comparisons are primarily with Q2 2019. Amounts are in U.S. dollars. Financial statements are unaudited and were reviewed by Ernst & Young.
Financial performance
| Metric | Q2 2020 | Q2 2019 |
|---|---|---|
| Net interest income | $1.018 billion | $981 million |
| Noninterest income | $692 million | $622 million |
| Total revenue, taxable-equivalent basis | $1.717 billion | $1.611 billion |
| Provision for credit losses | $482 million | $74 million |
| Noninterest expense | $1.013 billion | $1.019 billion |
| Net income attributable to Key common shareholders | $161 million | $405 million |
| Diluted earnings per common share | $0.17 | $0.40 |
| Net interest margin, taxable-equivalent | 2.76% | 3.06% |
Revenue rose 7% year over year, led by record consumer mortgage originations and fees and increased prepaid-card activity tied to state unemployment programs. Lower interest rates and balance-sheet mix reduced net interest margin. The sharp increase in credit-loss provision—reflecting CECL forecasts updated for COVID-19—was the main factor behind lower earnings. Q2 cash efficiency ratio was 57.9%, compared with 61.9% a year earlier.
For the six months ended June 30, net income attributable to Key was $333 million versus $832 million in 2019; net interest income was $1.999 billion versus $1.958 billion, and provision for credit losses was $841 million versus $136 million.
Balance sheet, liquidity and capital
- At June 30, total assets were $171.2 billion, loans $106.2 billion, deposits $135.5 billion, long-term debt $13.7 billion, and shareholders’ equity $17.5 billion.
- Loans increased $11.5 billion from year-end 2019, including more than $8 billion of Paycheck Protection Program (PPP) lending. Deposits increased $23.6 billion, reflecting client growth, stimulus payments and lower consumer spending.
- The allowance for loan and lease losses was $1.708 billion, up $808 million from year-end. Including the off-balance-sheet credit-loss liability, total allowance for credit losses was $1.906 billion. Q2 net charge-offs were $96 million, or 0.36% of average loans.
- Nonperforming assets rose to $951 million from $715 million at year-end; nonperforming loans were $760 million. The filing notes that eligible pandemic-related modifications may not be reported as nonperforming or past due.
- Capital ratios at quarter-end: Common Equity Tier 1 9.1%, Tier 1 risk-based 10.5%, total risk-based 12.8%, and leverage 8.8%. The company reported all capital ratios above regulatory minimums; KeyBank was considered “well capitalized” under the prompt corrective action framework.
- Liquidity included $34.8 billion of liquid assets, $26.7 billion of unused Federal Reserve borrowing capacity secured by loans, and $8.0 billion of unused FHLB capacity. The consolidated loan-to-deposit ratio was 80.4%.
- For the first half, operating cash flow was $105 million versus $730 million a year earlier; investing cash flow was negative $24.7 billion and financing cash flow was positive $25.0 billion. Cash and due from banks increased $327 million to $1.059 billion.
Material changes and management commentary
- Key adopted CECL on January 1, 2020, recording a $230 million after-tax reduction to retained earnings. The pandemic-driven forecast update contributed to the substantial first-half provision build.
- Commercial and Consumer Bank Q2 net income attributable to Key was $120 million and $91 million, respectively, versus $277 million and $177 million a year earlier.
- COVID-19 relief included payment deferrals and forbearance. At June 30, $3.1 billion of commercial loans and $1.5 billion of consumer loans were in short-term deferral or forbearance. Separately, $3.9 billion of eligible modifications were not reported as nonperforming under applicable relief rules.
- Key was the seventh-largest PPP lender by funding, with approximately $8 billion of PPP loans. The loans are SBA-guaranteed; Key recorded no allowance for the outstanding PPP balance.
- Management withdrew its full-year 2020 outlook because it could not estimate the pandemic’s impact. Long-term targets were unchanged: positive operating leverage, 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%.
- Common-share repurchases were temporarily suspended. The company paid a $0.185-per-share Q2 dividend and planned to maintain that level for Q3, subject to Board approval, which was subsequently granted. Federal Reserve restrictions also prohibited share repurchases in Q3 and limited common dividends.
- Management cited economic deterioration and uncertainty, particularly in COVID-sensitive sectors, as material risks. The filing identifies exposures including travel/tourism, oil and gas, retail commercial real estate, consumer-facing businesses and leveraged lending. Nonperforming loans also increased in oil and gas.
Risks, contingencies and unusual items
Key identifies COVID-19 effects, credit deterioration, commercial real estate conditions, concentrated commercial and industrial exposure, interest-rate and funding changes, operational and cybersecurity threats, regulatory requirements, and the LIBOR transition as important risks. Goodwill testing identified a pandemic-related triggering event, but management concluded it was not more-likely-than-not that any reporting unit’s fair value was below carrying value; further deterioration could require reassessment.
Outstanding guarantees had maximum potential undiscounted payments of $13.844 billion and recorded liabilities of $183 million; management assessed payment/performance risk as low. The company stated that litigation reserves were considered adequate and that known proceedings were not expected to materially adversely affect financial condition, while acknowledging outcomes could exceed reserves or affect a particular period.
Important facts for investors to verify
- How CECL assumptions and pandemic-related economic forecasts evolve, and whether subsequent credit-loss provisions materially exceed the Q2 build.
- Performance of deferred or forborne loans, including the $3.9 billion of modifications excluded from delinquency/nonperforming classifications.
- Credit quality and exposure trends in oil and gas, travel/tourism, commercial real estate and other pandemic-sensitive sectors.
- Whether deposit growth and liquidity remain durable as stimulus effects recede, and the effect of funding costs and lower rates on net interest margin.
- Dividend capacity and capital levels under evolving Federal Reserve distribution limits; confirm any later changes to repurchase or dividend plans.
- Whether goodwill valuation assumptions, legal contingencies, guarantees, and servicing-asset valuations change as economic conditions develop.