KeyCorp (KEY) — Q2 2018 Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2018. Financial statements are unaudited; Ernst & Young reported that its interim review identified no material modifications needed for GAAP conformity.
Business context and reporting period
KeyCorp is a bank holding company operating through Key Community Bank and Key Corporate Bank, serving consumers, businesses, and middle-market corporate clients. The filing compares Q2 and first-half 2018 results with the corresponding 2017 periods.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income, GAAP | $979 million | $973 million | $1.923 billion | $1.891 billion |
| Noninterest income | $660 million | $653 million | $1.261 billion | $1.230 billion |
| Provision for credit losses | $64 million | $66 million | $125 million | $129 million |
| Noninterest expense | $993 million | $995 million | $1.999 billion | $2.008 billion |
| Income from continuing operations attributable to Key | $479 million | $407 million | $895 million | $731 million |
| Net income attributable to Key common shareholders | $467 million | $398 million | $871 million | $694 million |
| Diluted common EPS | $0.44 | $0.36 | $0.81 | $0.63 |
| Taxable-equivalent net interest margin | 3.19% | 3.30% | 3.17% | 3.21% |
| Cash efficiency ratio | 58.8% | 59.3% | 60.8% | 62.4% |
At June 30, 2018, total assets were $137.8 billion, loans $88.2 billion, deposits $104.5 billion, long-term debt $13.9 billion, and shareholders’ equity $15.1 billion. The loan-to-deposit ratio was 86.9%. The allowance for loan and lease losses was $887 million, or 1.01% of period-end loans.
Six-month cash flows were $408 million provided by operating activities, $41 million provided by investing activities, and $336 million used in financing activities. Cash and due from banks ended the period at $784 million.
Capital ratios at quarter-end included Common Equity Tier 1 of 10.13%, Tier 1 risk-based capital of 10.95%, total risk-based capital of 12.83%, and leverage of 9.87%. The company estimated fully phased-in CET1 at 10.04%. Key reported $23.9 billion of liquid assets, $3.0 billion of parent-company cash, and a Modified LCR above 100%.
Material changes versus the prior comparable period
- Q2 net income attributable to Key rose 17.0% to $482 million; common diluted EPS increased to $0.44 from $0.36. First-half net income attributable to Key rose to $900 million from $736 million.
- Q2 taxable-equivalent net interest income was $987 million, flat year over year. Purchase-accounting accretion fell $72 million to $28 million; excluding that decline, net interest income increased $72 million and margin improved 13 basis points.
- Q2 noninterest income increased modestly, with stronger investment banking and mortgage servicing fees offset by lower leasing income. A $42 million lease residual loss affected Q2 leasing results.
- Q2 noninterest expense was nearly flat. Personnel expense rose $33 million, including $18 million of efficiency-related costs, while other expense declined, partly reflecting charitable contributions made in 2017.
- Community Bank Q2 net income increased to $244 million from $198 million. Corporate Bank net income declined to $167 million from $224 million, reflecting lower purchase-accounting accretion, loan spread compression, credit costs, and the lease residual loss.
- Average Q2 loans increased $2.1 billion year over year, led by commercial and industrial lending. Period-end loans rose $1.8 billion from December 2017; deposits declined $687 million as customers shifted toward higher-yielding products and noninterest-bearing balances fell.
- Net loan charge-offs were 0.27% of average loans in Q2 and 0.26% year to date, below the respective 2017 rates of 0.31% and 0.29%. Nonperforming assets increased $37 million from year-end to $571 million, primarily due to commercial and industrial credit migration.
Outlook, management commentary, risks and unusual items
- For 2018, management expected net interest income of $3.95–$4.05 billion, noninterest income of $2.5–$2.6 billion, and noninterest expense of $3.85–$3.95 billion. Average loans were projected at $88.5–$89.5 billion and average deposits at $104.5–$105.5 billion.
- Long-term targets are a 54%–56% cash efficiency ratio, net charge-offs of 0.40%–0.60% of average loans, and return on tangible common equity of 15%–18%. Q2 achieved 58.8%, 0.27%, and 16.73%, respectively.
- Key completed the sale of Key Insurance & Benefits Services on May 4 and reported a $73 million net gain. Separately, the income statement’s other income included a $78 million sale-related gain. The filing also cites a $42 million lease residual loss.
- The Federal Reserve did not object to the 2018 capital plan. It authorized up to $1.225 billion of share repurchases from Q3 2018 through Q2 2019; the Board declared a Q3 dividend of $0.17 per common share, up from $0.12 in Q2.
- Key expected the new CECL credit-loss standard, effective for the company January 1, 2020, to generally increase its allowance; the amount was not yet reasonably estimable. The filing also describes regulatory changes, interest-rate and funding sensitivity, commercial and industrial credit concentration, cybersecurity and operational risks, and uncertainty around litigation outcomes.
- Management said KeyBank met the regulatory definition of “well capitalized.” Legal proceedings were not expected to have a material adverse effect on financial condition based on information then available, but outcomes could exceed reserves or affect results in a particular period.
Most important facts for investors to verify
- Whether the 2018 revenue and expense outlook was achieved, particularly given deposit-cost increases and declining purchase-accounting accretion.
- Whether the Corporate Bank’s weaker quarterly earnings and elevated commercial and industrial credit migration persisted.
- The recurring earnings contribution versus one-time effects of the insurance sale gain, lease residual loss, and restructuring-related costs.
- Subsequent trends in nonperforming assets, charge-offs, and the allowance, including the eventual CECL adoption impact.
- Execution of the approved buyback and dividend plan while maintaining capital and liquidity buffers.
- Any material developments in litigation, guarantees, regulatory requirements, or cybersecurity and operational risks.