KEYCORP annual report, FY2010

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KeyCorp 2010 Form 10-K Summary

Business context and reporting period

KeyCorp is a Cleveland-based bank holding company whose principal subsidiary is KeyBank. It provides retail and commercial banking, lending, leasing, wealth management, investment banking and related services through Key Community Bank and Key Corporate Bank. At December 31, 2010, Key reported $91.8 billion in assets, 1,033 branches in 14 states and 15,610 average full-time-equivalent employees. This annual report covers the year ended December 31, 2010; financial statements are audited and presented under U.S. GAAP.

Financial performance and condition

  • Earnings: Net income attributable to Key common shareholders was $390 million, or $0.44 per diluted share, versus a $1.629 billion net loss, or $2.34 loss per diluted share, in 2009. Continuing-operations income attributable to common shareholders was $413 million, compared with a $1.581 billion loss in 2009. Total net income attributable to Key was $554 million.
  • Revenue and expenses: GAAP net interest income was $2.511 billion, up from $2.380 billion. Noninterest income was $1.954 billion, down 4%; noninterest expense fell 15% to $3.034 billion. Taxable-equivalent revenue was $4.491 billion, up 1%.
  • Margins and returns: Taxable-equivalent net interest margin was 3.26%, up 43 basis points. Return on average assets from continuing operations was 0.66%; fourth-quarter annualized return on average assets was 1.53%.
  • Credit costs and asset quality: Provision for loan and lease losses declined to $638 million from $3.159 billion. Net charge-offs were $1.570 billion, down $687 million; the net charge-off rate was 2.91% versus 3.40%. Nonperforming assets fell to $1.338 billion, or 2.66% of relevant assets, from $2.510 billion, or 4.25%. The allowance was $1.604 billion, 3.20% of loans and 150.19% of nonperforming loans.
  • Balance sheet and funding: Loans were $50.107 billion, down from $58.770 billion; deposits were $60.610 billion, down from $65.571 billion. Long-term debt was $10.592 billion, compared with $11.558 billion. The fourth-quarter loan-to-deposit ratio was 90%, versus 97% a year earlier.
  • Liquidity and cash flow: Key reported $11.7 billion in liquid assets and $3.3 billion in parent-company short-term investments. Unused secured borrowing capacity was $11.3 billion at the Federal Reserve Bank of Cleveland and $4.0 billion at the Federal Home Loan Bank of Cincinnati. Consolidated cash flows were $2.724 billion provided by operating activities, $1.974 billion provided by investing activities and $4.891 billion used in financing activities.
  • Capital: Tier 1 common equity ratio was 9.34%, Tier 1 risk-based capital 15.16%, total risk-based capital 19.12% and leverage ratio 13.02%. KeyBank was categorized as well capitalized under prompt corrective action standards.

Material changes versus 2009

  • Key returned to profitability after two years of substantial losses. Management attributed the improvement mainly to lower credit provisions, higher pre-provision net revenue, improved margins and cost control.
  • Credit measures improved, including lower nonperforming assets and charge-offs. The allowance declined by $930 million as credit conditions improved and loan balances contracted.
  • Loans and deposits contracted, while the securities available-for-sale portfolio increased to $21.933 billion from $16.641 billion. Management cited weak credit demand, client paydowns and the run-off of exit portfolios.
  • Common equity and regulatory capital ratios improved; Key raised no new capital in 2010 and issued $750 million of five-year senior unsecured debt.
  • Effective January 1, 2010, new consolidation guidance brought education-loan securitization trusts onto the balance sheet, adding $2.8 billion in assets, liabilities and equity and a $45 million after-tax adjustment to beginning retained earnings. The education lending business remained discontinued.

Outlook, risks and unusual items

  • Management said it was positioned to compete in 2011, citing stronger capital, liquidity and reserves, improving asset quality and early growth in core commercial lending. It cautioned that loan growth may not continue because some clients have ample liquidity.
  • Long-term targets include a 90%–100% loan-to-core-deposit ratio, a 0.40%–0.50% net charge-off ratio, net interest margin above 3.50%, noninterest income above 40% of revenue, return on average assets of 1.00%–1.25%, and $300–$375 million in Keyvolution run-rate savings by end-2012. At year-end, reported measures included a 2.00% net charge-off ratio, 3.31% fourth-quarter margin, 45% noninterest-income share, 1.53% fourth-quarter annualized return on assets and $228 million of savings implemented.
  • Management estimated the proposed debit-interchange rules could affect approximately $100 million of annual revenue; final effects were not yet clear. Regulation E was estimated to reduce deposit service-charge income by an annualized $40 million in the fourth quarter. Estimated 2011 FDIC assessment expense was $60–$90 million.
  • Material risks include commercial real estate weakness, regional economic conditions, borrower defaults, interest-rate and liquidity risk, ratings downgrades, competition, operational and legal risks, and the costs and effects of Dodd-Frank and Basel III. Moody’s downgraded KeyBank debt ratings one notch in November 2010. The resulting requirement to move $1.50–$1.85 billion in mortgage-servicing escrow balances to another institution was expected to cause an immaterial servicing-asset impairment; KeyBank said it had adequate liquidity to offset the deposits.
  • Key’s $2.5 billion U.S. Treasury CPP preferred investment restricts common dividends and share repurchases. The common dividend was $0.01 per quarter in 2010; KeyBank paid no dividends to the parent, which received $25 million from nonbank subsidiaries. The CPP preferred dividend rate is 5%, increasing to 9% after five years if the investment remains outstanding. Trust preferred securities represented $1.8 billion, or 15%, of Tier 1 capital and are subject to phase-out from Tier 1 eligibility beginning in 2013.
  • Unusual items include the 2009 comparison’s $241 million intangible-asset impairment, $106 million tax credit from IRS settlements, and gains on Visa shares and other transactions. 2010 included a $28 million gain from selling Tuition Management Systems and a $32 million deferred tax expense related to a change in the assertion on reinvesting foreign earnings. The 2010 loss from discontinued operations was $23 million, primarily related to education-loan trust fair-value adjustments.
  • Pending matters include shareholder derivative suits concerning executive compensation and disclosures, ERISA-related 401(k) litigation, Madoff-related claims involving Austin, and overdraft-practice litigation. Management stated that other ordinary-course legal matters were not expected to have a material adverse effect based on information then available.

Most important facts for investors to verify

  • Reconcile continuing-operations earnings, total net income and diluted EPS, including preferred dividends and discontinued operations.
  • Assess whether credit quality gains are durable, especially in commercial real estate, and whether the reduced allowance remains adequate as charge-offs continue.
  • Confirm core loan and deposit trends, funding costs, and the sustainability of the higher net interest margin amid low rates and weak loan demand.
  • Track the impact of the Moody’s-related escrow deposit transfer, ratings changes and the estimated FDIC and debit-interchange costs.
  • Review parent-company liquidity and dividend capacity given KeyBank’s inability to pay dividends without regulatory approval and the outstanding CPP investment.
  • Evaluate capital ratios under the trust-preferred phase-out, Basel III and Dodd-Frank rulemaking, and the potential for dilution from Treasury’s warrant or future capital issuance.
  • Review the assumptions underlying education-loan trust fair values, deferred tax assets, principal investments and other material valuation estimates, as well as developments in pending litigation.