KeyCorp (KEY) — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. KeyCorp is a U.S. bank holding company operating through KeyBank, with Key Community Bank and Key Corporate Bank as its principal business segments. Interim financial statements were reviewed by Ernst & Young, not audited.
Financial performance and condition
| Metric | Q3 2014 | Q3 2013 | 2014 YTD | 2013 YTD |
|---|---|---|---|---|
| Net interest income, GAAP | $575 million | $578 million | $1.711 billion | $1.742 billion |
| Net interest margin, taxable-equivalent | 2.96% | 3.11% | 2.98% | 3.16% |
| Noninterest income | $417 million | $459 million | $1.307 billion | $1.313 billion |
| Noninterest expense | $704 million | $716 million | $2.055 billion | $2.108 billion |
| Continuing-operations income attributable to Key common shareholders | $197 million | $229 million | $671 million | $618 million |
| Diluted EPS from continuing operations | $0.23 | $0.25 | $0.76 | $0.67 |
| Net income attributable to Key common shareholders, including discontinued operations | $180 million | $266 million | $630 million | $663 million |
| Diluted EPS, including discontinued operations | $0.21 | $0.29 | $0.71 | $0.72 |
- Q3 taxable-equivalent revenue was $998 million, down 4.3% from $1.043 billion. Pre-provision net revenue from continuing operations was $294 million, versus $327 million.
- Management attributed lower net interest income and margin mainly to lower earning-asset yields and excess liquidity from commercial deposit growth. Q3 noninterest income was pressured by lower leasing gains, principal-investing gains, and mortgage servicing fees; the prior-year quarter benefited from an early leveraged-lease termination.
- Q3 noninterest expense fell 1.7% year over year; lower personnel and efficiency-related costs were partly offset by Pacific Crest acquisition expenses. The cash efficiency ratio was 69.5%, versus 67.5%.
- At September 30, total assets were $89.8 billion, loans $56.2 billion, deposits $68.5 billion, long-term debt $7.2 billion, and total equity $10.5 billion. Loans increased about 4.8% year over year, led by commercial lending; deposits were broadly flat year over year.
- For the nine months, operating cash flow was $465 million, investing cash flow was $1.495 billion, financing cash flow was negative $1.926 billion, and cash and due from banks increased $34 million to $651 million. Cash plus short-term investments totaled $2.993 billion at quarter-end.
- Period-end capital ratios included Tier 1 common equity of 11.26%, Tier 1 risk-based capital of 12.01%, total risk-based capital of 14.10%, and leverage of 11.15%. The reported loan-to-deposit ratio was 87%.
Changes, strategy, and outlook
- Nonperforming loans declined to $401 million from $541 million a year earlier; nonperforming assets fell to $418 million from $579 million. Net charge-offs were $31 million, or 0.22% of average loans, versus $37 million, or 0.28%.
- The allowance for loan and lease losses was $804 million, 1.43% of loans, versus $868 million, 1.62%, a year earlier. Coverage was 200.5% of nonperforming loans, compared with 160.4%.
- On September 30, Key sold the residual interests in its education-loan securitization trusts for $57 million, deconsolidated trust assets of $1.7 billion and liabilities of $1.6 billion, and recorded a $25 million after-tax loss. Key retained servicing on certain loans. Discontinued operations overall reported a $17 million Q3 loss and a $41 million nine-month loss.
- Key acquired technology-focused investment bank Pacific Crest Securities in September, recording estimated goodwill of $72 million and identifiable intangible assets of $28 million. It also continued share repurchases, closed 31 branches, reduced fixed-income trading headcount by about 20%, and announced its intent to exit international leasing.
- Management expected full-year 2014 net interest income to be relatively stable versus 2013, with slight downward pressure; low single-digit growth in noninterest income; a low-to-mid-single-digit decline in noninterest expense; and mid-single-digit loan growth, mainly commercial. It expected provision expense to approximate net charge-offs and charge-off rates to remain below its 0.40%–0.60% long-term target range.
- Long-term targets include a 90%–100% loan-to-deposit ratio, net interest margin above 3.50%, cash efficiency ratio below 60%, return on assets of 1.00%–1.25%, and net charge-offs of 0.40%–0.60%. Q3 margin and efficiency ratio remained outside those targets.
- The estimated Modified Liquidity Coverage Ratio was 80% in Q3; Key must reach at least 90% by January 2016 and 100% by January 2017. Management reported $10.1 billion of liquid assets and additional secured borrowing capacity of $21.4 billion at quarter-end.
Risks, contingencies, and unusual items
- Key cited risks including credit deterioration, commercial real estate conditions, interest-rate changes, funding and liquidity costs, regulation and capital requirements, cybersecurity and operational failures, litigation, and execution of strategic initiatives.
- Potential future payments under disclosed guarantees totaled $15.0 billion undiscounted, with $109 million recorded as a liability. The largest category was standby letters of credit; management assessed payment/performance risk for the listed guarantee types as low.
- Legal matters included a pending Supreme Court petition in Metyk and continuing overdraft litigation. Key said other matters were not expected to have a material adverse effect based on information then available, while noting outcomes could exceed reserves and affect a particular period.
- Q3 pension expense included a $20 million settlement loss related to lump-sum payments; management expected an additional settlement loss in Q4. The filing also said an IRS settlement reduced the 2014 effective tax rate, partly offset by a write-off of a foreign deferred tax asset.
- The filing states that 2014 discontinued-operations results, consolidated net income, and related EPS were revised from results reported October 15, 2014; investors are referred to KeyCorp’s November 4, 2014 Form 8-K for details.
Important facts for investors to verify
- Review the November 4, 2014 Form 8-K reconciliation of revised discontinued-operations results and EPS, especially the education-loan trust sale accounting.
- Assess whether loan growth, deposit mix, credit quality, and the lower allowance remain consistent with the bank’s risk profile and stated charge-off expectations.
- Track net interest margin and expense trends against management’s full-year outlook and long-term targets.
- Verify progress toward Modified LCR requirements and the effect of regulatory capital rule changes, including the phase-out of trust preferred securities from Tier 1 capital.
- Monitor the Pacific Crest acquisition, the international leasing exit, outstanding legal proceedings, and material guarantee exposures.
- Confirm execution of the remaining share-repurchase authorization and the sustainability of the $0.065 quarterly common dividend.