KeyCorp (KEY) — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. KeyCorp is a regional bank holding company operating Consumer Bank and Commercial Bank segments. Results are unaudited; the independent accountant performed an interim review, not an audit.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Net interest income (GAAP) | $981 million | $979 million | +$2 million |
| Provision for credit losses | $74 million | $64 million | +$10 million |
| Noninterest income | $622 million | $660 million | -$38 million |
| Noninterest expense | $1.019 billion | $993 million | +$26 million |
| Income from continuing operations attributable to Key | $423 million | $479 million | -$56 million |
| Net income attributable to Key common shareholders | $405 million | $467 million | -$62 million |
| Diluted EPS | $0.40 | $0.44 | -$0.04 |
| Net interest margin, taxable-equivalent | 3.06% | 3.19% | -13 basis points |
| Cash efficiency ratio (non-GAAP) | 61.9% | 58.8% | +3.1 percentage points |
| Return on average tangible common equity (non-GAAP, continuing operations) | 13.69% | 16.73% | -3.04 percentage points |
Higher earning-asset balances and rates supported net interest income, but lower margin, higher deposit costs, lower loan fees, and declining purchase-accounting accretion constrained growth. Q2 taxable-equivalent net interest income was $989 million versus $987 million a year earlier. The prior-year quarter included a $73 million net gain on the KIBS sale and a $42 million operating-lease residual loss; these items affected comparisons of noninterest income.
For the six months, net income attributable to Key was $832 million versus $900 million; diluted EPS was $0.78 versus $0.81. Taxable-equivalent net interest income was $1.974 billion versus $1.939 billion, while noninterest income was $1.158 billion versus $1.261 billion and noninterest expense was $1.982 billion versus $1.999 billion.
Balance sheet, liquidity, capital and credit
- At June 30, 2019, total assets were $144.5 billion, loans $91.9 billion, deposits $109.9 billion, and long-term debt $14.3 billion. Compared with June 30, 2018, loans rose from $88.2 billion, deposits from $104.5 billion, and long-term debt from $13.9 billion.
- Six-month cash flows: operating activities provided $720 million (versus $408 million); investing activities used $3.473 billion (versus providing $41 million); financing activities provided $2.682 billion (versus using $336 million). Cash and due from banks fell $71 million to $607 million.
- Liquidity included $26.4 billion of liquid assets and unused secured borrowing capacity of $26.0 billion at the Federal Reserve Bank of Cleveland and $7.3 billion at the FHLB. The consolidated loan-to-deposit ratio was 86.1%.
- Reported capital ratios at quarter-end: Common Equity Tier 1 9.57%, Tier 1 risk-based 11.01%, total risk-based 13.03%, and leverage 10.00%. Tangible common equity to tangible assets was 8.59%.
- Credit remained described as stable. Net charge-offs were $65 million, or 0.29% of average loans, compared with $60 million, or 0.27%, in Q2 2018. Nonperforming loans were $561 million and nonperforming assets $608 million; nonperforming assets increased $31 million from year-end 2018. The allowance for loan and lease losses was $890 million.
- Commercial and industrial loans were $48.5 billion, about 53% of loans, and approximately 85% variable-rate. Commercial real estate loans declined 7.6% from year-end to $14.7 billion.
Material changes and management commentary
- Key acquired Laurel Road’s digital lending business on April 3. It reported more than $400 million of Q2 originations, and average consumer direct loans grew 33% year over year. Acquisition accounting included provisional $37 million of identifiable intangible assets and $148 million of goodwill.
- Investment banking and debt-placement fees reached a record second-quarter level. Management cited broad-based loan growth, stronger fee businesses, and substantially realized $200 million of targeted cost savings. Higher charitable contributions and volume-driven expenses offset some efficiency gains.
- Consumer Bank Q2 net income was $172 million versus $155 million; Commercial Bank net income was $283 million versus $256 million. Segment reporting was reorganized in Q1 2019; prior periods were restated.
- Key repurchased $180 million of common shares in Q2 and issued $450 million of Series G preferred shares. The announced capital plan permits up to $1.0 billion of common-share repurchases from Q3 2019 through Q2 2020. The Board approved a 9% dividend increase to $0.185 per share; the Q2 dividend was $0.17.
Outlook, risks and unusual items
- 2019 outlook: taxable-equivalent net interest income of $4.0–$4.1 billion, assuming one 25-basis-point rate decrease; noninterest income of $2.5–$2.6 billion; and noninterest expense of $3.85–$3.95 billion, excluding the disclosed Q3 subsequent event. Average loans were expected at $90–$91 billion and average deposits at $108–$109 billion.
- Management expected to reach its 54%–56% cash-efficiency target in the second half of 2019. It expected 2019 provision to slightly exceed net charge-offs to support loan growth and charge-offs to remain below its long-term 0.40%–0.60% target range.
- Subsequent event: Key disclosed fraudulent transactions associated with a business customer, discovered on or about July 9, 2019. The estimated exposure was up to $90 million net of tax; the final loss could be lower depending partly on recoveries. The company described it as an isolated incident involving one business relationship and said the investigation was ongoing.
- Key expected the January 1, 2020 CECL adoption to generally increase its loan-loss allowance, primarily for long-term consumer loans; the amount was not yet reasonably estimable. Other risks include credit deterioration, commercial real estate conditions and C&I concentration, interest-rate and funding-cost changes, litigation, operational and cyber risks, and regulatory changes. Legal proceedings were not believed likely to have a material adverse effect, though outcomes could exceed reserves. Guarantees had $11.9 billion maximum potential undiscounted payments and $134 million of recorded liabilities; management assessed payment risk as low.
Important facts for investors to verify
- Track the final financial impact and recoveries related to the post-quarter customer fraud, including any effects on later-period results.
- Compare realized net interest income, deposit costs and margin with the rate-cut assumption and 2019 guidance.
- Monitor whether the cash-efficiency target is achieved and whether expense trends improve after the Q2 increase.
- Assess credit trends, particularly consumer charge-offs, nonperforming assets, C&I concentration and commercial real estate exposure.
- Verify the pace and execution of planned repurchases and the increased dividend against capital ratios and regulatory requirements.
- Review the eventual CECL allowance impact and any material changes to the provisional Laurel Road acquisition valuations.