KeyCorp — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. KeyCorp is a regional bank holding company operating primarily through Key Community Bank and Key Corporate Bank. Amounts below are in U.S. dollars.
Financial performance and position
- Revenue: Taxable-equivalent revenue was $1.553 billion, up 3.1% from $1.506 billion a year earlier. GAAP net interest income was $944 million, up from $918 million; noninterest income was $601 million, up from $577 million.
- Profit: Continuing-operations income attributable to Key was $416 million versus $324 million. Income available to common shareholders from continuing operations was $402 million; diluted EPS was $0.38 versus $0.27. Net income attributable to Key was $418 million, including $2 million from discontinued operations.
- Margins and returns: Net interest margin (taxable-equivalent) was 3.15%, versus 3.13%. Return on average tangible common equity was 14.89%, compared with 10.98%; cash efficiency ratio was 62.9%, compared with 65.8%.
- Credit: Provision for credit losses was $61 million, down from $63 million. Net charge-offs were $54 million, or 0.25% of average loans, versus $58 million and 0.27%. Nonperforming loans were $541 million, up from $503 million at year-end 2017; nonperforming assets were $569 million.
- Cash flow: Operating activities used $211 million, compared with $405 million used in Q1 2017. Investing activities provided $749 million and financing activities used $566 million. Cash and due from banks declined $28 million during the quarter to $643 million.
- Balance sheet and funding: Total assets were $137.0 billion; loans were $88.1 billion, up from $86.4 billion at year-end; deposits were $104.8 billion, down from $105.2 billion. Long-term debt was $13.7 billion. The loan-to-deposit ratio was 86.9%.
- Liquidity and capital: Liquid assets totaled $22.3 billion, and the Modified LCR was above the 100% minimum. Key estimated fully phased-in Common Equity Tier 1 was 9.91%; reported CET1 was 9.99%, total risk-based capital 12.73%, and leverage 9.76%. KeyBank was considered well capitalized under the prompt corrective action framework.
Material changes versus comparable periods
- Revenue growth reflected higher interest rates, loan growth and fee businesses. Average loans rose $794 million year over year; commercial and industrial average loans increased 6.8%. Investment banking and debt placement fees reached a first-quarter record of $143 million, up 12.6%.
- Higher rates and low deposit betas supported net interest income, partly offset by purchase accounting accretion declining $20 million year over year to $33 million. Interest expense increased to $193 million from $132 million.
- Noninterest expense was approximately $1.0 billion, slightly below the prior-year $1.013 billion. Personnel costs rose 6.8%, reflecting acquisitions, technology investment and performance compensation; lower other expense, including the absence of a prior-year $20 million charitable contribution, offset some increases.
- Community Bank income increased to $196 million from $147 million. Corporate Bank income rose to $207 million from $180 million, although its taxable-equivalent revenue declined 3.3% to $559 million.
- Accumulated other comprehensive loss widened to $991 million from $779 million at year-end, mainly reflecting a $150 million after-tax loss on available-for-sale securities and a $63 million after-tax loss on derivatives during the quarter.
Outlook, management commentary and risks
- 2018 outlook: 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 expected at $88.5–$89.5 billion and average deposits at $104.5–$105.5 billion. Management expected provision expense to slightly exceed net charge-offs to support loan growth.
- Long-term targets: Cash efficiency ratio of 54%–56%, return on tangible common equity of 15%–18%, and net charge-offs of 0.40%–0.60% of average loans. Q1 actuals were outside the first two target ranges and below the charge-off range.
- The Board planned to consider raising the quarterly common dividend to as much as $0.12 per share in Q2; the Q1 dividend was $0.105. Key repurchased $199 million of common shares in Q1 under an authorization allowing up to $800 million through Q2 2018.
- Key agreed to sell Key Insurance & Benefits Services to USI Insurance Services; closing was expected in Q2 2018, subject to approvals and customary conditions.
- Key described interest-rate, credit, liquidity, regulatory, operational and cybersecurity risks. Its modeled 12-month net interest income exposure was -5.46% under a 150-basis-point rate decline, close to the -5.50% tolerance threshold; exposure under a 200-basis-point increase was +3.22%. Management noted model results depend on assumptions and customer behavior.
- Legal proceedings were not expected by management to have a material adverse effect on financial condition, but outcomes could exceed reserves and affect results in a particular period. Guarantees had maximum potential undiscounted payments of $10.1 billion, with $158 million of recorded liabilities; management assessed payment risk as low.
- Tax reform lowered the federal corporate rate to 21%. Q1 income tax expense was $62 million, including $26 million of net discrete benefits; the effective tax rate was 12.9%. The company expected to finalize its provisional tax-reform accounting by Q3 2018. Adoption of the expected-credit-loss standard in 2020 was expected to increase the allowance, but the amount was not yet reasonably estimable.
Most important facts for investors to verify
- Whether revenue, margin and loan growth can continue as deposit costs rise and purchase-accounting accretion declines.
- Whether nonperforming loans, particularly commercial and industrial exposures, stabilize after their increase from year-end.
- Progress toward expense, efficiency and return targets, including integration and investment costs from acquisitions.
- Capital and liquidity headroom after dividends, repurchases, loan growth and the planned insurance-services sale.
- Final tax-reform accounting and the eventual allowance impact and implementation of the expected-credit-loss standard.
- Potential interest-rate, securities valuation, legal, guarantee and cybersecurity exposures, and the assumptions underlying management’s outlook.