KEYCORP quarterly report, Q3 FY2009

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KeyCorp 10-Q Summary: Third Quarter 2009

Business context and reporting period. KeyCorp, a U.S. bank holding company, reported the quarter and nine months ended September 30, 2009. Its principal businesses are Community Banking and National Banking. Financial statements are unaudited; the independent accountant performed an interim review, not an audit.

Financial performance and position

  • Third-quarter results: Net interest income was $592 million and noninterest income was $382 million, for combined revenue of $974 million, down from $1.068 billion a year earlier. Provision for loan losses was $733 million, versus $336 million. Noninterest expense was $901 million, versus $740 million.
  • Profit and per-share results: Net loss attributable to Key was $397 million; loss attributable to common shareholders was $438 million, or $0.52 per diluted share. In Q3 2008, the comparable losses were $36 million attributable to Key and $48 million attributable to common shareholders, or $0.10 per diluted share. Continuing-operations loss attributable to common shareholders was $422 million, versus $9 million.
  • Nine-month results: Net loss attributable to Key was $1.111 billion, versus $944 million in 2008; common-shareholder loss was $1.364 billion, or $2.14 per diluted share, versus $956 million, or $2.19 per share. Net interest income was $1.750 billion, compared with $1.699 billion; noninterest income was $1.566 billion, compared with $1.464 billion.
  • Margins and credit costs: Taxable-equivalent net interest margin improved to 2.80% from 2.70% in Q2 2009, but remained below 3.17% in Q3 2008. Net charge-offs were $587 million, or 3.59% of average loans, up from $233 million, or 1.28%, a year earlier. The loan-loss allowance was $2.485 billion, or 4.00% of loans, versus $1.390 billion, or 1.90%, a year earlier.
  • Asset quality: Nonperforming assets increased to $2.799 billion from $1.236 billion a year earlier; nonperforming loans were $2.290 billion. Management expected nonperforming loans and charge-offs to remain elevated and potentially increase.
  • Balance sheet and funding: Total assets were $96.989 billion, down from $104.531 billion at December 31, 2008. Loans were $62.193 billion, down from $72.835 billion; deposits were $67.259 billion, up from $65.127 billion. Long-term debt declined to $12.865 billion from $14.995 billion; total equity was $11.188 billion.
  • Capital: At September 30, Tier 1 risk-based capital was 12.61%, total risk-based capital 16.65%, and Tier 1 common equity 7.64%. Key reported it had met the SCAP requirement to generate at least $1.8 billion of additional Tier 1 common equity. The bank qualified as “well capitalized” under applicable regulatory thresholds.
  • Cash flows, nine months: Operating activities provided $1.467 billion and investing activities provided $4.064 billion; financing activities used $6.051 billion. Cash and due from banks ended the period at $725 million, down from $1.245 billion at the start of the year.
  • Liquidity: Management reported a $9.5 billion liquid-asset portfolio and unused secured borrowing capacity of $14.9 billion at the Federal Reserve and $4.1 billion at the Federal Home Loan Bank. Its stress analysis indicated it could fund operations for at least one year without extraordinary government intervention.

Material changes versus comparable periods

  • Credit deterioration drove a sharp increase in provisions, charge-offs, impaired loans and nonperforming assets; commercial real estate was a major source of stress.
  • Q3 revenue declined year over year, while expenses rose, including higher FDIC assessments, OREO costs and a $45 million write-off of equipment-leasing-related intangible assets.
  • Deposits grew while loans and wholesale borrowings contracted. The securities portfolio increased to $15.4 billion from $8.2 billion at September 30, 2008, primarily reflecting purchases of mortgage-backed securities and portfolio repositioning.
  • Capital transactions materially expanded the common share count: approximately 878.6 million shares were outstanding at September 30, 2009, versus 495.0 million at December 31, 2008. Common dividends were reduced to $0.01 per share quarterly.

Outlook, commentary, risks and unusual items

  • Management described the economy as stabilizing but the recovery as uncertain, with high unemployment, weak commercial real estate conditions and constrained credit markets. It cited deposit growth and improving net interest margin as positives.
  • Management expected nonperforming loans and net charge-offs to remain elevated and allowance levels could rise further. Key reported that commercial real estate vacancies and declining property values could further weaken borrowers and collateral.
  • Key exited government-guaranteed education lending and began winding down Austin, its hedge-fund investment subsidiary; both were treated as discontinued operations. Education-loan originations were expected to continue through December 4, 2009, with exit costs expected through June 30, 2010. Key also ceased lending in commercial vehicle and office-equipment leasing markets.
  • The “Keyvolution” program was expected to generate annualized cost savings of $300 million to $375 million by 2012. No specific earnings or revenue guidance was provided.
  • Unusual items include the $45 million Q3 intangible-asset impairment; a $17 million pretax loss related to exchanging common shares for capital securities; and prior-period gains from securities repositioning and Visa share sales. The 2008 comparison also reflects significant leveraged-lease tax charges. Key said it had resolved material federal tax issues for 1997–2003, deposited $2.0 billion with the IRS for anticipated taxes and interest, and accrued $32 million for potential state penalties.
  • Contingencies include Heartland Payment Systems’ card-data breach: KeyBank had received assessments from Visa and MasterCard, was appealing them, and had not recorded a reserve because net exposure after potential indemnification could not be quantified. Other disclosed matters include Madoff-related claims against Austin and a consolidated ERISA class action; Key said it intended to defend the claims.
  • Risks include further deterioration in commercial real estate and borrower credit, funding or rating pressure, interest-rate changes, higher FDIC costs, and possible additional capital needs. A proposed FDIC assessment prepayment was estimated at $500 million to $525 million. A downgrade could increase collateral or funding requirements.

Most important facts for investors to verify

  • Whether credit losses, nonperforming assets and commercial real estate exposures continue to rise, and whether the $2.485 billion loan-loss allowance proves adequate.
  • Whether the reported capital ratios and liquidity resources remain resilient as losses and FDIC assessments affect earnings and cash needs.
  • The effect of substantial common-share issuance and preferred-stock obligations on future per-share results and distributions.
  • Actual costs and timing of the education-lending and Austin exits, and progress toward the $300 million to $375 million Keyvolution savings target.
  • Developments in Heartland-related assessments and indemnification, state tax penalties, litigation, and the proposed FDIC prepayment.