KeyCorp (KEY) — Q2 2014 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2014; comparisons are primarily with the same 2013 periods. KeyCorp operates through Key Community Bank and Key Corporate Bank. Education lending, Victory and Austin are reported as discontinued operations.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income, GAAP | $573 million | $581 million | $1.136 billion | $1.164 billion |
| Net interest margin, taxable-equivalent | 2.98% | 3.13% | 2.99% | 3.18% |
| Noninterest income | $455 million | $429 million | $890 million | $854 million |
| Noninterest expense | $689 million | $711 million | $1.351 billion | $1.392 billion |
| Provision for loan and lease losses | $10 million | $28 million | $16 million | $83 million |
| Continuing income attributable to Key common shareholders | $242 million | $193 million | $474 million | $389 million |
| Diluted continuing EPS | $0.27 | $0.21 | $0.53 | $0.42 |
| Net income attributable to Key common shareholders, including discontinued operations | $214 million | $198 million | $450 million | $397 million |
Q2 taxable-equivalent revenue was $1.034 billion, up 1.9% year over year. The non-GAAP cash efficiency ratio was 65.8%, versus 69.1%; continuing-operations return on average assets was 1.14%, versus 0.95%. Q2 common dividend declared was $0.065 per share, compared with $0.055.
Financial condition, liquidity and capital
- At June 30, total assets were $91.8 billion, loans $55.6 billion, deposits $67.8 billion, long-term debt $8.2 billion and total equity $10.5 billion. Loans grew from $53.1 billion a year earlier; deposits were broadly unchanged. Long-term debt rose from $6.7 billion.
- Cash and due from banks was $604 million; short-term investments were $3.2 billion. Management reported a $10.4 billion liquid asset portfolio and unused borrowing capacity of $19.5 billion at the Federal Reserve Bank of Cleveland and $2.8 billion at the FHLB.
- Period-end loan-to-deposit ratio was 87.1%. Key reported total risk-based capital of 14.14%, Tier 1 risk-based capital of 11.99%, Tier 1 common equity of 11.25%, and tangible common equity to tangible assets of 10.15%.
- For the first half, operating cash flow was $263 million, compared with $925 million in 2013; investing cash flow was $1.082 billion provided, versus $1.605 billion used; financing cash flow was $1.358 billion used, versus $792 million provided. Prior-year operating cash flow included $297 million of net FDIC reimbursement/payments.
Material changes and credit quality
- Q2 continuing common earnings rose to $242 million from $193 million, driven by lower provision and expenses and higher noninterest income. Net interest income and margin declined as lower asset yields and loan fees outweighed loan growth; deposit-cost reductions partly offset the pressure.
- Noninterest income increased 6.1% in Q2. Investment banking and debt placement fees rose $15 million, principal-investing gains rose $20 million, and leasing income included a $17 million leveraged-lease termination gain. Lower deposit service charges and trust and investment services income partly offset these items.
- Loans grew 4.7% year over year at period end, led by commercial, financial and agricultural loans. Commercial loans increased 6.9%; consumer loans were nearly flat.
- Asset quality improved: nonperforming loans fell to $396 million from $652 million a year earlier, and nonperforming assets to $410 million from $693 million. The allowance for loan and lease losses was $814 million, or 1.46% of loans, versus $876 million, or 1.65%; coverage of nonperforming loans increased to 205.6% from 134.4%. Q2 net charge-offs were $30 million, or 0.22% of average loans.
- Q2 discontinued operations recorded a $28 million net loss, versus $5 million income a year earlier. Education lending fair-value changes were a key drag: Key reported a $22 million after-tax loss related to trust loans and securities during Q2.
Outlook, commentary and risks
- Management expected 2014 net interest income to be relatively stable versus 2013, with slight downward pressure; low-single-digit growth in noninterest income; and a low- to mid-single-digit decline in noninterest expense. It maintained guidance for mid-single-digit full-year loan growth, primarily commercial, and expected provision to approximate net charge-offs for the rest of the year. Charge-offs were expected to remain below the 0.40%–0.60% long-term target.
- Long-term targets include net interest margin above 3.50%, cash efficiency ratio of 60%–65%, return on average assets of 1.00%–1.25%, and loan-to-core-deposit ratio of 90%–100%. Q2 margin and efficiency remained outside their respective targets; loan-to-deposit ratio was below target.
- On July 17, 2014, Key announced a definitive agreement to acquire Pacific Crest Securities, subject to regulatory approval, with expected closing in Q3 2014. Key also planned up to $542 million of common share repurchases through Q1 2015; $108 million was repurchased in Q2.
- Risks include economic and real-estate weakness, borrower defaults, interest-rate and funding changes, regulatory and capital requirements, cybersecurity and operational risks, and litigation. A class settlement in Madoff-related litigation awaited court approval; the overdraft litigation was remanded for further consideration of KeyBank’s arbitration provision. Management said the settlement was expected to be covered by insurance and not materially affect financial condition, while cautioning that legal outcomes could exceed reserves.
- Maximum undiscounted payments under guarantees totaled $14.5 billion, with $97 million recorded as liability; standby letters of credit made up most of the maximum exposure. Key disclosed no default guarantees outstanding.
Important facts for investors to verify
- Whether loan growth and improved credit quality continue, and whether charge-offs remain below management’s target range.
- Whether margin pressure stabilizes and the company meets its 2014 revenue, expense and loan-growth outlook.
- The drivers and repeatability of Q2 gains, particularly the leveraged-lease gain and principal-investing income, and the continuing education-loan fair-value losses.
- Capital-plan execution, dividend sustainability, and the effect of upcoming regulatory capital rules, including the phase-out of trust preferred securities from Tier 1 capital.
- Pacific Crest acquisition approvals and closing, and developments in the legal matters, guarantees and liquidity position.