KeyCorp — Q1 2016 Form 10-Q
Business context and reporting period
KeyCorp is a bank holding company operating through Key Community Bank and Key Corporate Bank. This unaudited quarterly report covers the three months ended March 31, 2016; balance-sheet comparisons are primarily with December 31, 2015, and March 31, 2015. Ernst & Young conducted an interim review, not an audit.
Financial performance and condition
- Revenue and earnings: GAAP net interest income was $604 million, up from $571 million a year earlier; noninterest income was $431 million, down from $437 million. Net income attributable to Key was $188 million, versus $233 million; income from continuing operations attributable to Key common shareholders was $182 million, or $0.22 per diluted share, versus $222 million, or $0.26. The effective tax rate was 23.0%, compared with 24.4%.
- Margins and expenses: Net interest margin was 2.89%, versus 2.91%. Noninterest expense rose 5.1% to $703 million, including $24 million of First Niagara merger costs; excluding those costs, expense increased 1.5% to $679 million. Taxable-equivalent cash efficiency ratio was 66.6% (64.3% excluding merger costs). Taxable-equivalent pre-provision net revenue was $340 million, versus $345 million.
- Credit: Provision for credit losses increased to $89 million from $35 million. Net charge-offs were $46 million, or 0.31% of average loans, versus $28 million, or 0.20%. Nonperforming loans rose to $676 million from $387 million at year-end and $437 million a year earlier; nonperforming assets were $692 million. The allowance for loan and lease losses was $826 million, 1.37% of loans, and 122.2% of nonperforming loans, down from 181.7% a year earlier.
- Balance sheet and funding: Total assets were $98.4 billion; loans were $60.4 billion, up from $58.0 billion a year earlier. Deposits were $73.4 billion, and long-term debt was $10.8 billion, up from $8.7 billion a year earlier. Total equity was $11.1 billion. The loan-to-deposit ratio was 86%.
- Cash flow and liquidity: Operating activities provided $373 million, compared with $1.102 billion used in Q1 2015. Investing activities used $3.337 billion, principally reflecting a $2.729 billion increase in short-term investments; financing activities provided $2.831 billion. Cash and due from banks ended at $474 million. Management reported an $18.8 billion liquid asset portfolio, $17.6 billion of unused borrowing capacity secured by loans, and a Modified Liquidity Coverage Ratio above 100%.
- Capital and shareholder returns: Common Equity Tier 1 was 11.07%, Tier 1 risk-based capital 11.38%, and total risk-based capital 13.12%. The quarterly common dividend was $0.075 per share. Open-market share repurchases remained suspended due to the pending First Niagara acquisition.
Material changes versus comparable periods
- Net income attributable to Key declined about 19% year over year, despite higher net interest income; the main pressure was the $54 million increase in credit-loss provision. Higher noninterest expense and the absence of the prior-year $29 million principal-investing gain also weighed on results.
- Loan growth was concentrated in commercial lending. Average loans increased $2.6 billion year over year, while consumer loans declined. Average deposits increased $2.8 billion, with growth in interest-bearing balances partly offset by lower noninterest-bearing deposits.
- Credit quality weakened materially: nonperforming loans increased $239 million year over year, and the allowance-to-nonperforming-loans ratio fell. Management attributed approximately 90% of the year-over-year increase in nonperforming loans and assets to oil and gas exposure.
- Key’s reported capital ratios remained strong, while long-term debt increased and the securities portfolio grew to $19.3 billion from $18.1 billion a year earlier.
Outlook, management commentary, and risks
- Management expected 2016 net interest income growth in the low-to-mid-single digits without higher rates, or mid-single digits if rates rose; noninterest income growth in the low-to-mid-single digits; and average loan growth in the mid-single digits. Expense excluding merger costs was expected to be relatively stable with 2015.
- Management expected the allowance-to-period-end-loans ratio to remain relatively stable and net charge-offs to remain below its 0.40%–0.60% target range for the rest of 2016. The company’s longer-term targets include a 3.00%–3.25% net interest margin, cash efficiency below 60%, and return on average assets of 1.00%–1.25%.
- The First Niagara merger, valued at approximately $4.1 billion under announced terms, had shareholder approval and was expected to close in Q3 2016, subject to regulatory and other conditions. On April 28, 2016, the companies agreed to sell 18 Buffalo-area branches to address antitrust requirements. The Board was to consider a dividend increase to $0.085 per share in May.
- Management described a weak start to 2016, citing subdued consumer spending, slow housing activity, global-growth concerns, and low interest rates. Risks include further deterioration in oil and gas or other credit portfolios, interest-rate and deposit-pricing uncertainty, funding access and credit-rating changes, regulatory costs, cybersecurity and operational failures, litigation, and merger execution or integration.
- Guarantees had maximum potential undiscounted payments of $15.5 billion and recorded liabilities of $157 million; the filing assessed payment/performance risk for these guarantee categories as low. Management stated other litigation was not expected to have a material adverse effect based on information then available, while noting that outcomes could exceed reserves and affect a particular period.
Important facts for investors to verify
- Whether oil and gas credit migration, nonperforming loans, charge-offs, and reserve coverage stabilize or worsen.
- Whether the First Niagara transaction receives regulatory approval, closes on schedule, and delivers expected benefits after branch divestitures and merger costs.
- Whether actual loan and deposit repricing, interest-rate movements, and liquidity needs support management’s net interest income outlook.
- How reported capital, liquidity, and debt evolve, including the effects of regulatory requirements and planned capital returns.
- Whether legal proceedings, guarantees, or other contingencies produce losses materially above recorded reserves.