KeyCorp (KEY) — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless noted. The interim statements received an accountant’s review, not an audit.
Business context and reporting period
KeyCorp is a bank holding company operating through Community Banking and National Banking, alongside corporate treasury, principal investing and exit portfolios. It continued to wind down education lending and Austin Capital Management; both are reported as discontinued operations. During Q1, Key reorganized certain business lines and exit portfolios, with prior periods recast for segment comparisons.
Financial and operating metrics
| Metric | Q1 2010 | Q1 2009 or comparison |
|---|---|---|
| Net interest income, GAAP | $625 million | $589 million |
| Net interest margin, continuing operations, taxable-equivalent | 3.19% | 2.79%; up 15 basis points from Q4 2009 |
| Noninterest income | $450 million | $478 million |
| Provision for loan losses | $413 million | $847 million |
| Noninterest expense | $785 million | $927 million, including $196 million of impairment in Q1 2009 |
| Continuing-operations pretax loss | $123 million | $707 million loss |
| Net loss attributable to Key common shareholders | $96 million; diluted loss per share $0.11 | $536 million; diluted loss per share $1.09 |
| Operating cash flow | $843 million | $68 million used |
| Cash flow from investing / financing | $200 million used / $495 million used | — |
The company reported a consolidated net loss of $39 million and a net loss attributable to Key of $55 million; preferred dividends and discount amortization brought the loss attributable to common shareholders to $96 million. Q1 2009 included a $105 million Visa share-sale gain and a $196 million continuing-operations intangible impairment charge, among other items.
- Balance sheet at March 31: Total assets $95.3 billion; deposits $65.1 billion; long-term debt $11.2 billion; total equity $10.9 billion. Continuing-operations loans were $55.9 billion, down from $58.8 billion at December 31, 2009 and $70.0 billion a year earlier.
- Liquidity: Management reported $11.6 billion of liquid assets, including $3.6 billion at the Federal Reserve, and unused secured borrowing capacity of $12.1 billion at the Federal Reserve Bank of Cleveland and $3.8 billion at the Federal Home Loan Bank. The consolidated loan-to-deposit ratio was 93%, versus 115% in Q1 2009.
- Capital: Tier 1 common equity ratio was 7.51%; Tier 1 risk-based capital 12.92%; total risk-based capital 17.07%. These ratios are regulatory or non-GAAP measures as applicable.
- Credit: Allowance for loan losses was $2.425 billion, or 4.34% of continuing-operations loans. Net charge-offs were $522 million, or 3.67% of average loans, versus $460 million, or 2.60%, a year earlier. Nonperforming loans were $2.065 billion, down from $2.187 billion at year-end but above $1.735 billion a year earlier; nonperforming assets were $2.428 billion.
- Shareholder items: Common dividend declared was $0.01 per share, versus $0.0625 a year earlier. Approximately 879 million shares were outstanding at quarter-end, compared with approximately 499 million a year earlier; prior-period capital transactions materially affect per-share comparisons.
Material changes versus comparable periods
- The common-share loss narrowed substantially year over year, principally alongside a lower loan-loss provision and the absence of the prior-year impairment charge. Lower funding costs and improved loan yields raised the continuing-operations net interest margin.
- Revenue was broadly flat on a taxable-equivalent basis overall, while noninterest income fell 6% on a GAAP basis. The comparison reflects the prior-year Visa gain; principal investing moved from losses to gains, partly offsetting lower lease income and gains on leased equipment.
- Credit costs improved versus Q1 2009 in provision expense, but charge-offs increased year over year and remain elevated. Nonperforming loans improved sequentially, while remaining higher than a year earlier.
- Deposits and funding mix improved: growth in noninterest-bearing and transaction accounts offset declines in time deposits, and management reduced reliance on wholesale funding. Continuing-operations loans declined amid weak credit demand, client deleveraging and portfolio runoff.
- Effective January 1, 2010, new consolidation guidance required Key to consolidate ten education-loan securitization trusts. This added approximately $2.8 billion of assets and liabilities, including $2.6 billion of loans at fair value, to discontinued operations and increased beginning retained earnings by $45 million after tax. Trust assets are restricted to trust obligations and holders have no recourse to Key.
Outlook, management commentary, risks and unusual items
- Management outlook: Key expected net charge-offs to remain elevated during 2010 but trend downward as the year progressed. Management said deposit repricing and funding mix could continue to support margins, while noting that actual margin outcomes depend on rates, balance-sheet mix and customer behavior. Long-term goals include a 90%–100% loan-to-core-deposit ratio, 40–50 basis points of net charge-offs, net interest margin above 3.50%, and $300–$375 million of annualized efficiency savings by the end of 2012. These are goals, not quarterly earnings guidance.
- Credit and real estate risk: Management cited continued weakness in commercial real estate, especially nonowner-occupied property, with elevated vacancies, reduced rents and property values. It warned further deterioration could impair borrower cash flows and collections. Net charge-offs were expected to remain high despite signs of moderation in some portfolios.
- Regulatory and revenue risks: KeyBank elected not to extend participation in the FDIC’s Transaction Account Guarantee program beyond June 30, 2010 and anticipated some deposit runoff, while stating its liquidity buffer should limit the effect. Key estimated Regulation E overdraft opt-in rules could reduce deposit service-charge income by approximately $50 million annually. Proposed FDIC assessment changes and broader financial regulatory reform could increase costs or affect ratings and competitiveness.
- Liquidity and capital considerations: KeyBank could not pay dividends to the parent without regulatory approval as of March 31, 2010; the parent held $3.4 billion in short-term investments and reported these as sufficient for projected maturities. Management also expected the deferred tax asset disallowed from regulatory capital to increase until taxable income is generated.
- Contingencies: Key disclosed Taylor/Wildes ERISA litigation, Madoff-related claims involving Austin, and DataTreasury patent litigation; management said it intended to defend the claims and had established reserves where appropriate. A Heartland payment-card intrusion matter could result in significant net charges if Heartland cannot meet indemnification obligations; the exposure was not quantifiable and no reserve was recorded. The filing reports $15.5 billion of maximum potential undiscounted financial-guarantee payments and $207 million of recorded liabilities, with management assessing payment/performance risk as low.
- Other notable items: Other real estate owned expense rose to $32 million from $6 million. The FDIC assessment expense was $37 million. The filing identified valuation estimates, loan-loss allowances, derivatives, taxes and contingencies as areas requiring significant judgment. Management reported disclosure controls effective and no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Reconcile the $96 million common-share loss to the $39 million consolidated loss, including preferred dividends, noncontrolling interests and discontinued operations.
- Assess credit trends beyond the sequential decline in nonperforming loans: charge-offs rose year over year, and commercial real estate remains a significant concentration and risk.
- Review allowance adequacy and the assumptions behind education-trust fair values, particularly the wide expected credit-loss and default ranges disclosed.
- Verify liquidity after the TAG program exit, the potential deposit runoff, and the parent company’s dependence on subsidiary dividends and external funding.
- Track the earnings effect of Regulation E, FDIC assessment changes, and the projected timing of efficiency savings and margin improvement.
- Monitor litigation, Heartland indemnification recoveries, guarantee exposure and any changes in credit ratings or collateral requirements.