KeyCorp 2019 Q3 Form 10-Q Summary
Reporting period: Quarter ended September 30, 2019; comparisons are primarily with the quarter ended September 30, 2018. KeyCorp is a U.S. bank holding company operating through Consumer Bank and Commercial Bank segments. Interim financial statements are unaudited; Ernst & Young reviewed them and reported no material modifications needed for GAAP conformity.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | Change / context |
|---|---|---|---|
| Net interest income, GAAP | $972 million | $986 million | Down 1.4%; taxable-equivalent net interest income was $980 million versus $993 million. |
| Net interest margin, taxable-equivalent | 3.00% | 3.18% | Lower, principally reflecting higher deposit costs and lower loan fees. |
| Provision for credit losses | $200 million | $62 million | Includes $123 million related to a previously disclosed fraud loss. |
| Noninterest income | $650 million | $609 million | Up 6.7%; included a $15 million gain on sale of an investment. |
| Noninterest expense | $939 million | $964 million | Down 2.6%, reflecting expense initiatives and elimination of the FDIC surcharge. |
| Income from continuing operations attributable to Key | $413 million | $482 million | Down 14.3%. |
| Net income attributable to Key common shareholders | $386 million | $468 million | Diluted EPS was $0.39 versus $0.45. |
| Cash efficiency ratio | 56.0% | 58.7% | Reached the top end of the 54%–56% target range; management described it as the lowest in over a decade. |
For the first nine months of 2019, net income attributable to Key was $1.248 billion, compared with $1.382 billion in 2018; diluted common EPS was $1.17 versus $1.26. GAAP net interest income was $2.930 billion versus $2.909 billion, while noninterest income was $1.808 billion versus $1.870 billion and noninterest expense was $2.921 billion versus $2.963 billion.
Balance sheet and funding at September 30: Total assets were $146.7 billion, loans $92.8 billion, deposits $111.6 billion, long-term debt $14.5 billion, and shareholders’ equity $17.1 billion. Loans and deposits increased from year-end 2018; the period-end loan-to-deposit ratio was 85.3%. Key reported $27.9 billion of liquid assets and unused secured borrowing capacity of $25.0 billion at the Federal Reserve Bank of Cleveland and $7.5 billion at the FHLB. KeyCorp held $4.2 billion in cash.
Capital: Common Equity Tier 1 was 9.48%, Tier 1 risk-based capital 10.91%, total risk-based capital 12.90%, and leverage 9.93%. Tangible common equity to tangible assets was 8.58%. The bank said its capital ratios exceeded regulatory requirements and KeyBank met the “well capitalized” PCA thresholds.
Cash flows, nine months: Operating activities provided $1.899 billion; investing activities used $5.958 billion; financing activities provided $4.017 billion. Cash and due from banks declined $42 million, ending at $636 million. These cash-flow figures reflect banking balance-sheet activity and should not be read as conventional free cash flow.
Material changes and operating developments
- The $123 million fraud-related charge-off drove much of the increase in provision and quarterly net charge-offs. Net charge-offs were $196 million, or 0.85% of average loans, versus $60 million, or 0.27%, a year earlier. Management said trailing 12-month charge-offs remained within its 0.40%–0.60% through-cycle target.
- Average loans rose $3.5 billion year over year to $92.0 billion. Commercial and industrial loans grew, while commercial real estate and construction balances declined; consumer growth in Laurel Road, residential mortgage, and indirect auto more than offset home-equity runoff.
- Average deposits rose $4.7 billion year over year to $110.3 billion, but interest-bearing deposit expense increased, contributing to margin pressure.
- Nonperforming assets increased to $711 million from $577 million at December 31, 2018. The filing attributes the increase chiefly to three criticized commercial loans and residential mortgages transferred to nonperforming loans held for sale. Nonperforming loans were $585 million, or 0.63% of period-end portfolio loans.
- Business reporting was realigned in Q1 2019 into Consumer Bank and Commercial Bank; prior-period segment results were restated. Laurel Road’s digital lending business was acquired in April 2019.
- Key repurchased $248 million of common shares in Q3 and declared a $0.185-per-share dividend, a 9% increase from the prior quarter. It issued $750 million of 2.550% senior notes due 2029 during September.
Outlook, commentary, risks, and unusual items
- For Q4 2019, management expected taxable-equivalent net interest income to be relatively stable; average loans up 1%–3%; average deposits relatively stable; noninterest income up 1%–3%; and noninterest expense up 1%–3% versus Q3. It expected provision to slightly exceed net charge-offs to support loan growth and charge-offs to be relatively stable excluding the fraud loss.
- Management cited record third-quarter investment banking and debt placement fees and said these activities were positioned well for Q4. Mortgage income and servicing fees were also increasing following investments in the mortgage business.
- Key announced that CEO and Chair Beth Mooney would retire effective May 1, 2020; President and COO Christopher Gorman was named her successor.
- Key expected adoption of the new expected-credit-loss standard (CECL) on January 1, 2020 to increase the allowance for loan and lease losses by approximately 20%–30% from current reserve levels, based on then-current forecasts and balances. The estimate remained subject to model refinement and economic conditions; longer-duration consumer reserves were expected to more than double.
- Key identified credit deterioration, commercial real estate fundamentals, concentrated commercial and industrial exposure, fraud, interest-rate and funding changes, LIBOR transition, cybersecurity, operational and compliance failures, litigation, and regulatory changes among risks. Key had an enterprise-wide LIBOR transition program; LIBOR was not expected to remain available after 2021.
- Management did not believe pending legal matters would have a material adverse effect on financial condition, but cautioned that outcomes could exceed reserves and affect results in a particular period. Guarantees had maximum potential undiscounted payments of $12.1 billion, with $130 million of recorded liabilities; management assessed payment/performance risk as low.
- October 2019 regulatory rules described in the filing were expected by Key not to have a material impact. The filing also notes ongoing fair-value estimates and assumptions for servicing assets and other instruments, which may change with market conditions.
Most important facts for investors to verify
- Whether the fraud-related loss is fully contained, whether any further losses or recoveries emerge, and how the event affected credit controls and the C&I portfolio.
- Whether CECL implementation ultimately produces the estimated 20%–30% allowance increase and what that means for reserves, provision expense, and earnings.
- Whether credit quality stabilizes: monitor net charge-offs, criticized commercial loans, nonperforming assets, and commercial real estate exposures.
- Whether deposit pricing and interest rates continue to pressure net interest margin, and whether Q4 balance, fee, and expense expectations are achieved.
- Capital and shareholder returns: confirm regulatory capital trends, the remaining authorization under the $1.0 billion repurchase plan, and the sustainability of dividends and buybacks.