KeyCorp 10-Q Summary: First Quarter 2012
Business context and reporting period
KeyCorp, an Ohio bank holding company, reported unaudited results for the three months ended March 31, 2012, compared with the first quarter of 2011. Its principal businesses are Key Community Bank and Key Corporate Bank. Education lending and Austin are reported as discontinued operations; the education-loan trusts remain on the balance sheet but their assets are generally restricted to settling trust obligations.
Financial performance and condition
| Metric | Q1 2012 | Q1 2011 or comparison |
|---|---|---|
| Taxable-equivalent revenue from continuing operations | $1.031 billion | $1.061 billion |
| Net interest income (GAAP) | $553 million | $597 million |
| Net interest margin (taxable-equivalent) | 3.16% | 3.25% |
| Noninterest income | $472 million | $457 million |
| Noninterest expense | $703 million | $701 million |
| Provision for loan and lease losses | $42 million | $40 million credit |
| Continuing-operations income attributable to Key | $205 million | $274 million |
| Net income attributable to Key | $200 million | $263 million |
| Net income attributable to common shareholders | $194 million; diluted EPS $0.20 | $173 million; diluted EPS $0.19 |
| Operating cash flow | $63 million | $412 million |
Q1 2012 investing cash flow was $606 million and financing cash flow was negative $947 million; cash and due from banks fell $278 million to $416 million. Operating cash flow was affected by movements in other operating activities, so it should not be read as a simple earnings proxy.
At March 31, total assets were $87.4 billion, loans $49.2 billion, deposits $61.5 billion, long-term debt $8.9 billion, and Key shareholders’ equity $10.1 billion. The loan-to-deposit ratio was 87%. The $11.6 billion liquid-asset portfolio was supplemented by unused secured borrowing capacity of $13.2 billion at the Federal Reserve Bank of Cleveland and $5.0 billion at the Federal Home Loan Bank of Cincinnati.
Capital remained strong: Tier 1 risk-based capital was 13.29%, total risk-based capital 16.68%, Tier 1 common equity 11.55%, and tangible common equity to tangible assets 10.26%. The filing reports return on average assets of 1.02% and an efficiency ratio of 68% for continuing operations.
Material changes versus the prior comparable period
- Taxable-equivalent net interest income decreased $45 million; the margin narrowed 9 basis points, reflecting lower asset yields and fewer earning assets in a low-rate environment.
- Noninterest income increased $15 million, including a $23 million rise in gains on leased equipment, mainly from a $20 million early-termination gain on a leveraged lease. Electronic banking fees fell $13 million following debit interchange price controls.
- Expenses were nearly flat. Lower FDIC assessments and operating-lease costs were largely offset by higher personnel and other expenses.
- Common-shareholder continuing income increased to $199 million from $184 million, despite lower continuing income attributable to Key. Q1 2011 included a $49 million deemed dividend related to TARP preferred-stock repurchase, which reduced common earnings.
- Credit indicators improved year over year: net charge-offs were $101 million, or 0.82% of average loans, versus $193 million, or 1.59%; nonperforming assets fell to $767 million from $1.089 billion. The allowance declined to $944 million, or 1.92% of loans, from $1.372 billion, or 2.83%.
- Commercial, financial and agricultural loans grew 20% year over year to $19.8 billion, while commercial real estate loans declined 15% to $9.1 billion. Total continuing-operations loans were $49.2 billion, up from $48.6 billion a year earlier.
Outlook, commentary, risks and unusual items
- Management expected the net interest margin to remain relatively stable in Q2 2012, with potential expansion in the second half from debt and deposit repricing. These are forward-looking expectations, not guarantees.
- Management anticipated modest further asset-quality improvement and a declining allowance-to-loans ratio. It also set long-term targets including a 90%–100% loan-to-core-deposit ratio, 0.40%–0.50% net charge-offs, margin above 3.50%, efficiency ratio of 60%–65%, and return on assets of 1.00%–1.25%. Q1 margin, charge-offs, efficiency and loan-to-deposit ratio were outside those targets.
- Key announced plans to repurchase up to $344 million of common shares, with repurchases beginning in April 2012. A proposed dividend increase from $0.03 to $0.05 per share was to be considered by the Board in May; it was not yet declared in this filing.
- Key agreed to acquire 37 Buffalo and Rochester branches, with approximately $2.4 billion in deposits and $400 million in loans. Closing was expected early in Q3 2012; OCC approval was received April 18, after quarter-end.
- Regulatory risks include Dodd-Frank requirements, possible restrictions on derivatives, stress testing, debit interchange limits, and the planned phase-out of certain trust-preferred securities from Tier 1 capital beginning in 2013. Management said Basel III capital requirements appeared manageable, while its liquidity impact remained uncertain.
- Key disclosed no European sovereign debt exposure; net European commercial and derivative exposure was reported at $1.381 billion, predominantly nonfinancial counterparties. Market, credit, liquidity, valuation, regulatory, cybersecurity and legal risks remain relevant.
- An Austin-related acquisition lawsuit continued; the court denied Key’s motion to dismiss in February 2012. Key stated that other known legal matters were not expected to have a material adverse effect, while noting outcomes are uncertain.
- Guarantees included $10.2 billion of standby letters of credit and total maximum undiscounted guarantee payments of $13.2 billion, against $157 million of recorded liabilities. The filing assessed payment/performance risk for guarantee categories as low.
Important facts for investors to verify
- Whether margin stabilizes and improves as forecast, and how ongoing low rates and deposit repricing affect net interest income.
- Whether credit improvement continues, particularly in commercial real estate, restructured loans, and exit portfolios; compare charge-offs and nonperforming assets with the reduced allowance.
- How much Q1 earnings depended on the leveraged-lease gain and other nonrecurring or variable income items.
- Whether the branch acquisition closes on schedule and delivers expected deposit funding, and whether the proposed dividend increase is approved.
- Capital and liquidity effects of regulatory changes, including the trust-preferred phase-out, Basel III implementation, and potential derivative collateral demands after ratings changes.
- Developments in the Austin litigation, guarantee exposures, and the valuation assumptions for education-loan trusts and other Level 3 assets.
The interim financial statements were reviewed by Ernst & Young, not audited; the review report stated it was not aware of material modifications needed for GAAP presentation.