KeyCorp (KEY) — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. KeyCorp is a diversified bank holding company operating primarily through its Consumer Bank and Commercial Bank. Results reflect the COVID-19 pandemic, low interest rates, government support programs, and adoption of CECL accounting on January 1, 2020.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Change / context |
|---|---|---|---|
| Net interest income | $1.000 billion | $972 million | Up 2.9%; lower funding costs and loan growth offset lower asset yields. |
| Provision for credit losses | $160 million | $200 million | Lower year over year; Q3 2019 included a $123 million previously disclosed fraud loss. |
| Noninterest income | $681 million | $650 million | Up 4.8%, including higher cards and payments and consumer mortgage income. |
| Noninterest expense | $1.037 billion | $939 million | Up 10.4%, notably from payments-related expenses, incentives, and pandemic costs. |
| Continuing income attributable to Key common shareholders | $397 million | $383 million | Diluted continuing EPS was $0.41 versus $0.38. |
| Net income attributable to Key common shareholders | $401 million | $386 million | Diluted EPS was $0.41 versus $0.39. |
| Net interest margin, taxable-equivalent | 2.62% | 3.00% | Down 38 basis points, reflecting lower rates, elevated liquidity, and PPP participation. |
| Cash efficiency ratio | 60.6% | 56.0% | Higher; this is a non-GAAP measure. |
For the first nine months, net income attributable to Key was $761 million, down from $1.248 billion; diluted EPS was $0.70 versus $1.17. Net interest income rose to $2.999 billion from $2.930 billion, but provision expense increased to $1.001 billion from $336 million.
Balance sheet, liquidity, capital, and cash flow
- At September 30, 2020, total assets were $170.5 billion, loans $103.1 billion, deposits $136.7 billion, and long-term debt $12.7 billion. Since year-end 2019, assets increased $25.6 billion and deposits increased $24.9 billion.
- Loan growth included more than $8 billion of PPP lending. Average Q3 loans increased $13.0 billion year over year; average deposits increased $24.7 billion.
- Liquidity: the liquid asset portfolio was $36.9 billion; unused secured borrowing capacity was $24.4 billion at the Federal Reserve Bank of Cleveland and $8.6 billion at the FHLB. The consolidated loan-to-deposit ratio was 77.2%. KeyCorp held $3.8 billion in cash.
- Capital: Common Equity Tier 1 was 9.5%, within Key’s stated 9.0%–9.5% target range; total risk-based capital was 13.3%. The filing says KeyBank met the “well capitalized” PCA criteria.
- Q3 common dividend was $0.185 per share. Share repurchases were suspended; Federal Reserve restrictions also limited repurchases and dividends for large banks in Q3 and were extended into Q4.
- Nine-month operating cash flow was $727 million versus $1.913 billion in 2019; investing cash flow was negative $24.543 billion and financing cash flow positive $24.040 billion. Financing inflows were principally supported by $24.876 billion of deposit growth. Bank cash-flow figures are affected by changes in loans, securities, and short-term investments.
Material changes and credit quality
- Commercial Bank Q3 net income fell to $160 million from $301 million, while Consumer Bank net income increased to $241 million from $196 million. Commercial results reflected higher provision expense and expenses, despite balance-sheet growth.
- CECL adoption reduced opening retained earnings by $230 million, net of deferred taxes, and increased the opening continuing-operations loan allowance by $204 million. At September 30, the continuing-operations allowance for loan and lease losses was $1.730 billion, versus $900 million at year-end 2019; the total allowance for credit losses, including off-balance-sheet exposures, was $1.938 billion.
- Q3 net charge-offs were $128 million, or 0.49% of average loans. Nonperforming loans were $834 million, up from $577 million at year-end 2019; nonperforming assets were $1.003 billion, up from $715 million. Management attributed the increase mainly to oil and gas nonperforming loans and a commercial property transferred to OREO.
- COVID-related modified loans totaled $3.1 billion commercial and $1.8 billion consumer at quarter-end. Key elected not to apply TDR accounting to $4.5 billion of qualifying COVID-related modifications; such loans could also be excluded from delinquency and nonperforming reporting under applicable relief provisions. Management reported that forbearance requests had declined and loans under forbearance were less than 2% of outstanding balances.
- Commercial loans were $74.5 billion, including $55.0 billion of C&I loans. Commercial real estate was $15.0 billion; oil and gas exposure was $2.1 billion. PPP loans were 100% SBA-guaranteed, and no allowance was deemed necessary for the $8.0 billion outstanding.
Outlook, risks, and unusual items
- Key withdrew its full-year 2020 financial outlook, citing its inability to estimate the pandemic’s impact. Long-term targets were unchanged: positive operating leverage and a 54%–56% cash efficiency ratio, 0.40%–0.60% net charge-offs through a credit cycle, and 16%–19% return on average tangible common equity.
- Management described credit quality as solid, with past dues improving quarter over quarter, while continuing heightened surveillance of commercial borrowers and pandemic-sensitive sectors. CECL estimates depend on economic forecasts and management judgments; management cautioned that future loss estimates could vary considerably.
- Key announced it would stop originating indirect auto loans; the approximately $4.6 billion existing portfolio is expected to run off over time.
- Key disclosed a new risk that PPP participation may lead to regulatory scrutiny, litigation, financial liability, legal and compliance costs, or reputational harm. Key had provided $8 billion in PPP funding and was the seventh-largest lender overall.
- Other key risks include pandemic-related economic deterioration, commercial real estate and concentrated commercial credit exposures, oil and gas, cyber and operational risks, litigation, funding and interest-rate risks, and the LIBOR transition. Management expected operational readiness for SOFR in Q4 2020.
- A COVID-related interim goodwill impairment test found no impairment at September 30, 2020. The interim financial statements received an independent accountant’s review, not a full audit.
Investor verification priorities
- Track allowance levels and CECL forecast assumptions against realized charge-offs, delinquency migration, and criticized loans, particularly in C&I, oil and gas, and commercial real estate.
- Verify the performance and repayment status of modified and forborne loans, including loans not reported as TDRs or delinquent under pandemic relief guidance.
- Assess whether deposit growth and elevated liquidity persist, and how low rates affect net interest margin and earnings.
- Monitor capital ratios, Federal Reserve distribution restrictions, dividend sustainability, and the timing of any resumption of share repurchases.
- Follow PPP-related litigation and regulatory developments, indirect auto portfolio runoff, and the timing and risks of LIBOR-to-SOFR transition.