KEYCORP quarterly report, Q3 FY2012

KeyCorp (KEY) 10-Q Summary: Third Quarter 2012

Reporting period: Quarter and nine months ended September 30, 2012. KeyCorp is a bank holding company operating through KeyBank, with Community Bank and Corporate Bank segments. Amounts are in millions unless noted. Interim statements were reviewed, not audited.

Financial performance

Metric	Q3 2012	Q3 2011	Key comparison
Net interest income	$572	$549	Up 4.2%; taxable-equivalent net interest margin was 3.23%, versus 3.09%.
Noninterest income	$544	$483	Up 12.6%; gains and other income included unusual items described below.
Noninterest expense	$734	$692	Up 6.1%, partly reflecting acquisitions and higher personnel costs.
Provision for loan and lease losses	$109	$10	Higher provision reduced earnings.
Net income attributable to Key common shareholders	$214	$212	Diluted EPS was $0.23 versus $0.22. Continuing-operations common income was $214 versus $229; continuing-operations EPS was $0.23 versus $0.24.

• Nine-month results: Net interest income was $1.663 billion versus $1.710 billion; noninterest income was $1.501 billion versus $1.394 billion; and noninterest expense was $2.151 billion versus $2.073 billion. Provision was $172 million, compared with a $38 million credit in 2011. Continuing-operations income attributable to common shareholders was $634 million versus $656 million. Diluted EPS was $0.67 versus $0.71. Total common income was $639 million versus $619 million, reflecting discontinued operations and the prior-year preferred-stock item.
• Returns and efficiency: Q3 return on average assets from continuing operations was 1.08%; return on average common equity was 8.57%; cash efficiency ratio was 64.62%. The reported long-term efficiency target is 60%–65%.
• Cash flow, nine months: Operating cash flow was $656 million versus $1.875 billion in 2011; investing cash flow was positive $3.015 billion versus $1.363 billion; financing cash flow was negative $3.391 billion versus negative $2.688 billion. Investing cash flow included $866 million received in acquisitions. Cash and due from banks ended at $974 million.

Financial condition, capital and liquidity

• At September 30, total assets were $86.950 billion, loans were $51.419 billion, deposits were $64.188 billion, long-term debt was $6.119 billion, and total equity was $10.279 billion. Compared with September 30, 2011, loans increased from $48.195 billion and deposits from $61.032 billion; long-term debt declined from $10.717 billion.
• Allowance for loan and lease losses was $888 million, or 1.73% of loans, down from $1.131 billion and 2.35% a year earlier. Nonperforming loans were $653 million, down from $788 million; nonperforming assets were $718 million, down from $914 million. The allowance equaled 136% of nonperforming loans.
• Capital remained substantial: Tier 1 common equity ratio was 11.30%, Tier 1 risk-based capital 12.10%, total risk-based capital 15.17%, and leverage ratio 11.37%. The company estimated a 10.41% Tier 1 common equity ratio under its interpretation of fully phased-in proposed Basel III rules; these are estimates, not finalized regulatory requirements.
• Key reported a $8.6 billion liquid-asset portfolio and unused secured borrowing capacity of $13.6 billion at the Federal Reserve Bank of Cleveland and $5.3 billion at the Federal Home Loan Bank of Cincinnati. The loan-to-deposit ratio was 86%, below its 90%–100% long-term target. The filing states that KeyBank paid $1.4 billion in dividends to KeyCorp during the first nine months and had $628 million of dividend capacity at quarter-end.

Changes versus comparable periods and business developments

• Q3 taxable-equivalent net interest income rose to $578 million from $555 million in Q3 2011, helped by lower-cost deposits, deposit growth and reduced funding costs. The reported GAAP amount was $572 million.
• Total loans grew year over year, led by commercial, financial and agricultural lending. Commercial real estate loans declined to $8.6 billion from $9.4 billion a year earlier. Deposits benefited from business demand deposits and the Western New York branch acquisition.
• Key acquired 37 Western New York branches in July, with approximately $2 billion of assets and deposits assumed, and acquired approximately $718 million of Key-branded credit card assets in August. Fair value estimates for parts of the acquisitions remained subject to completion.
• Credit quality generally improved: nonperforming assets declined for a twelfth consecutive quarter and the allowance fell year over year. However, Q3 net charge-offs rose sequentially to $109 million from $77 million, with a significant effect from new regulatory treatment of certain Chapter 7 bankruptcy loans.

Outlook, commentary, risks and unusual items

• Management described the U.S. recovery as modest and noted ongoing low interest rates and economic uncertainty. Long-term targets include net interest margin above 3.50%, noninterest income above 40% of revenue, net charge-offs of 0.40%–0.50%, return on assets of 1.00%–1.25%, and an efficiency ratio of 60%–65%. Q3 margin was 3.23% and net charge-offs to average loans were 0.86%.
• Key expects $150 million–$200 million of annual expense run-rate reductions by December 2013, including $30 million–$50 million by the end of 2012. It also reported that its $5 billion small- and medium-sized business lending commitment through 2014 had already been met.
• Unusual items: Q3 other income included a $54 million gain associated with redemption of trust preferred securities. Early leveraged-lease terminations generated $39 million in leased-equipment gains, partly offset by a $13 million write-off of capitalized loan-origination costs. The acquisitions and Chapter 7-related loan treatment contributed approximately $32 million and $45 million, respectively, to Q3 provision expense.
• Key repurchased $82 million of common shares in Q3, declared a $0.05 per-share dividend, and redeemed $707 million of trust preferred securities. Remaining share-repurchase authority was $177 million, with repurchases expected through Q1 2013.
• Risks include credit deterioration, interest-rate and liquidity changes, valuation uncertainty, regulatory reforms including Basel III and Dodd-Frank, and economic weakness. Management expects the allowance ratio to continue declining in Q4 if credit quality improves as anticipated; this is not earnings guidance.
• Legal matters include Madoff-related claims and overdraft-practice litigation. The overdraft matter remained at an early stage after an appellate remand; the filing says it is too early to determine whether it could materially affect financial condition. Management cautions that legal outcomes may exceed reserves. Maximum potential future payments on listed guarantees were $13.429 billion, with $153 million recorded as liabilities; management assessed payment/performance risk as low.
• The filing corrected a prior-period error in Q3 2011 related to education-loan securitization trusts by reducing accrued assets and retained earnings by $30 million. Key said the error was not material and did not restate prior periods or affect results of operations.

Most important facts for investors to verify

• Whether revenue and margin gains persist as lower reinvestment yields and low market rates continue, and how much Q3 noninterest income depended on one-time gains.
• Whether credit costs normalize after the $45 million Chapter 7-related impact and acquisition-related provision; monitor charge-offs, nonperforming assets, TDRs and allowance coverage.
• Whether the branch and credit-card acquisitions deliver expected growth and efficiency after integration costs and final fair-value adjustments.
• Progress toward the $150 million–$200 million expense-reduction goal and the long-term margin, credit-quality and return targets.
• Final Basel III rules and their effect on capital, liquidity and distributions; also verify the sustainability of dividends and share repurchases.
• Developments in legal proceedings, guarantee exposures and the valuation of assets reliant on unobservable assumptions.