KeyCorp (KEY) — Second-Quarter 2009 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2009. Financial amounts are in millions of dollars unless otherwise noted. Interim statements were reviewed, not audited; the independent accountant reported no material modifications needed for GAAP conformity.
Business context and financial results
KeyCorp is a bank holding company operating through Community Banking and National Banking, with lending, deposits, wealth management, equipment finance and capital-markets businesses. Results reflected a weak economy, rising credit costs and actions to bolster capital. Management described modest signs of economic improvement but continued pressure on borrowers and financial markets.
| Metric | Q2 2009 | Q2 2008 | Six months 2009 | Six months 2008 |
|---|---|---|---|---|
| Net interest income, GAAP | $592 | $358 | $1,206 | $1,071 |
| Noninterest income | $715 | $547 | $1,200 | $1,071 |
| Provision for loan losses | $850 | $647 | $1,725 | $834 |
| Noninterest expense | $870 | $777 | $1,812 | $1,506 |
| Net loss attributable to Key | $(226) | $(1,126) | $(714) | $(908) |
| Net loss attributable to Key common shareholders | $(390) | $(1,126) | $(926) | $(908) |
| Loss per common share, diluted | $(0.68) | $(2.70) | $(1.73) | $(2.23) |
- Q2 net interest margin was 2.67%, down from 2.77% in Q1 2009 and 3.32% in Q2 2008 after excluding the prior-year leveraged-lease litigation impact. Management cited lower asset yields, nonperforming loans, higher-cost deposit mix and increased lower-yielding liquid assets.
- Q2 noninterest income included $125 of securities-repositioning gains, a $95 gain on exchanging common shares for capital securities, and a $32 gain on sale of a Lehman bankruptcy claim. These items materially lifted reported revenue.
- Q2 continuing-operations loss attributable to Key was $236; common-share results also reflected $164 of preferred-stock dividends and related deemed dividend, including a $114 noncash deemed dividend.
Financial condition, credit and liquidity
- At June 30, 2009, total assets were $97.8 billion, down from $104.5 billion at December 31, 2008. Loans were $70.8 billion, versus $76.5 billion at year-end; total deposits were $67.9 billion, up from $65.3 billion.
- Allowance for loan losses was $2.50 billion, or 3.53% of loans, compared with $1.80 billion, or 2.36%, at year-end 2008 and $1.42 billion, or 1.87%, a year earlier. Q2 net charge-offs were $539 million, or 2.99% of average loans.
- Nonperforming assets rose to $2.55 billion from $1.46 billion at year-end 2008; nonperforming loans were $2.19 billion. Impaired loans increased to $1.92 billion. Management expected nonperforming loans to continue rising in 2009 and charge-offs to remain elevated, with further reserve increases possible.
- Six-month cash flow: $588 provided by operating activities, $3.07 billion provided by investing activities and $4.19 billion used in financing activities. Cash and due from banks declined $534 to $723.
- Long-term debt was $13.46 billion; bank notes and other short-term borrowings were $1.71 billion, down from $8.48 billion at year-end 2008. Key reported $7.2 billion of liquid assets and unused secured borrowing capacity of $19.0 billion at the Federal Reserve and Federal Home Loan Bank combined. Management said stress tests indicated capacity to fund operations for at least one year under a severe scenario.
- Capital ratios at quarter-end: Tier 1 risk-based 12.57%, total risk-based 16.67%, leverage 12.26% and Tier 1 common equity 7.36%. The Tier 1 common equity ratio was 5.62% at year-end 2008. KeyBank qualified as “well capitalized” under regulatory thresholds.
Material changes, capital actions and unusual items
- Regulators’ SCAP assessment required Key to raise $1.8 billion of additional Tier 1 common or contingent common equity. Key said it had met the requirement through common-stock issuance, preferred-stock and institutional capital-securities exchanges, securities sales and reduced dividend and interest obligations. The Q2 capital actions substantially increased shares outstanding.
- After quarter-end, Key completed a retail capital-securities exchange, issuing 81.3 million common shares and generating approximately $505 million of additional Tier 1 common equity. Verify the post-quarter transaction’s final accounting and resulting dilution.
- Common dividends were reduced to $0.01 per share per quarter from $0.0625; management said it did not expect to raise the dividend above $0.01 for the foreseeable future. Key paid the U.S. Treasury a $31 million quarterly dividend on Series B preferred stock.
- Key recorded a $196 million noncash intangible-asset impairment in Q1 2009 and wrote off all goodwill assigned to National Banking. Austin Capital Management was classified as a discontinued operation after management decided to curtail it; its Q2 discontinued-operations result was income of $10 million, while first-half discontinued operations showed a $12 million loss.
- The Q2 2008 comparison was unusually depressed by a $1.011 billion after-tax charge related to leveraged-lease tax litigation. Key and the IRS resolved the outstanding federal issues for tax years 1997–2003; Key had deposited $2.0 billion with the IRS for expected tax and interest payments. Key accrued $32 million for potential state penalties.
- FDIC assessments increased materially: Q2 expense was $70 million versus $2 million a year earlier, including a $44 million special assessment. Keyvolution targeted $300–$375 million of annualized cost savings by 2012; management reported an approximately 8% workforce reduction over 15 months.
Outlook, risks and contingencies
- Management cited continued weakness in credit quality, especially commercial real estate, marine and non-government-guaranteed education lending. Progress in reducing selected exit portfolios was slower than anticipated because of weak markets and restricted liquidity.
- Key identified risks from further economic deterioration, additional loan losses, insufficient reserves, asset-value declines, interest-rate changes, capital-market disruption and funding costs. Credit-rating downgrades could restrict liquidity, increase collateral requirements and raise funding costs.
- Outstanding contingent exposures included standby letters of credit with $13.09 billion maximum potential payments and $100 million recorded liability; total listed financial guarantees had $14.25 billion maximum potential payments and $201 million recorded liability. These maximum amounts are not expected-loss estimates; management assessed payment/performance risk as low.
- KeyBank faced unresolved Visa and MasterCard assessments related to the Heartland Payment Systems data intrusion. Key pursued appeals and had indemnification rights against Heartland, but had not recorded a reserve because the net exposure could not be quantified. Austin-related Madoff claims and ERISA litigation were also pending; the filing described insurance coverage for the Madoff matter subject to a $25 million deductible and policy terms.
- Management was evaluating new accounting rules effective in 2010 concerning financial-asset transfers and variable-interest-entity consolidation; their effects were not yet clear.
Investor verification priorities
- Track quarterly charge-offs, nonperforming assets, impaired loans and allowance coverage, particularly commercial real estate and exit portfolios.
- Separate recurring revenue and earnings from securities gains, capital-exchange gains, Lehman-claim proceeds and other unusual items.
- Verify SCAP compliance, capital ratios after the post-quarter exchange, and dilution from common-share issuance and preferred or capital-security exchanges.
- Monitor deposit mix, FDIC assessments, funding access, credit ratings and the availability of secured liquidity.
- Follow IRS/state tax settlement payments and potential penalties, Heartland assessments and indemnification recovery, and Austin/Madoff litigation developments.