KeyCorp 10-Q Summary — Third Quarter 2017
Business context and reporting period
KeyCorp is a regional banking and financial services company operating through Key Community Bank and Key Corporate Bank. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2017. Comparisons with 2016 are affected by the August 2016 acquisition of First Niagara; its results were included from the acquisition date, so 2017 includes a fuller contribution.
Financial performance and condition
| Metric | Q3 2017 | Q3 2016 | Change / context |
|---|---|---|---|
| Net interest income (GAAP) | $948 million | $780 million | Up 21.5%; Q3 2017 taxable-equivalent NII was $962 million. |
| Net interest margin (taxable-equivalent) | 3.15% | 2.85% | Improved with acquisition benefits, higher yields, and increased balances. |
| Noninterest income | $592 million | $549 million | Up 7.8%. |
| Noninterest expense | $992 million | $1.082 billion | Down 8.3%; Q3 2017 included $36 million of merger-related charges versus $189 million in Q3 2016. |
| Provision for credit losses | $51 million | $59 million | Lower, reflecting a large C&I recovery. |
| Continuing-operations income attributable to Key common shareholders | $349 million; diluted EPS $0.32 | $165 million; diluted EPS $0.16 | Substantial increase; results included merger charges and a merchant-services gain adjustment. |
For the first nine months, continuing-operations net income attributable to Key common shareholders was $1.038 billion, versus $540 million in 2016; diluted EPS was $0.95 versus $0.60. Net income attributable to Key, including discontinued operations and noncontrolling interests, was $1.100 billion for the nine months. The first nine months of 2017 included $161 million of merger-related charges and a $64 million one-time gain on the Key Merchant Services acquisition, partly offset by a $5 million third-quarter adjustment to that gain.
At September 30, loans were $86.5 billion, deposits $103.4 billion, total assets $136.7 billion, and long-term debt $15.1 billion. The loan-to-deposit ratio was 86.2%. Shareholders’ equity was $15.2 billion. Common Equity Tier 1 was 10.26%, Tier 1 risk-based capital 11.11%, and total risk-based capital 13.09%; Key reported capital above regulatory minimums.
Credit metrics improved year over year: net charge-offs were $32 million, or 0.15% of average loans, versus $44 million, or 0.23%. Nonperforming loans were $517 million (0.60% of period-end portfolio loans), down from $723 million (0.85%). The allowance for loan and lease losses was $880 million, or 1.02% of period-end loans.
For the first nine months, operating cash flow was $1.079 billion, investing cash flow was negative $833 million, and financing cash flow was negative $361 million. Cash and due from banks ended at $562 million. Key also reported a $25.4 billion liquid-asset portfolio and substantial unused secured borrowing capacity. KeyCorp’s Modified LCR was above the 100% minimum.
Material changes versus comparable periods
- First Niagara materially enlarged the balance sheet and contributed to year-over-year growth in loans, deposits, net interest income, and fee income. Average Q3 loans rose $9.1 billion and average deposits $8.2 billion from Q3 2016.
- Q3 continuing-operations income attributable to Key common shareholders more than doubled year over year, while reported noninterest expense declined because merger charges were much lower than in 2016. Excluding merger charges, Q3 noninterest expense increased $63 million, or 7.1%, year over year, reflecting acquisition-related costs and business investments.
- For the nine months, GAAP noninterest expense increased 18.3% to $3.0 billion, primarily reflecting the expanded business following First Niagara. Noninterest income increased 25.4% to $1.822 billion.
- Commercial and industrial lending grew; commercial real estate loans declined from year-end 2016 amid paydowns and planned reductions in acquired loans. Consumer loans decreased modestly, mainly from home-equity paydowns.
Outlook, management commentary, risks, and unusual items
- Management expected full-year 2017 net interest income of $3.8–$3.9 billion, noninterest income of $2.35–$2.45 billion, and noninterest expense excluding merger-related charges of $3.7–$3.8 billion. The NII outlook assumed no additional 2017 rate increases.
- Management anticipated fourth-quarter average loans of $87–$87.5 billion and full-year average deposits of $102.5–$103 billion. It expected remaining-2017 provision expense to slightly exceed net charge-offs to support loan growth, with charge-offs remaining below its 0.40%–0.60% target range.
- Long-term targets include positive operating leverage, cash efficiency below 60%, net charge-offs of 0.40%–0.60%, and return on tangible common equity of 13%–15%. Q3 reported cash efficiency was 62.2% (59.7% excluding notable items) and return on tangible common equity was 12.21% (13.19% excluding notable items).
- Key repurchased $277 million of common shares in Q3 under an authorization of up to $800 million through Q2 2018. The board planned to consider a quarterly dividend increase to as much as $0.105 in Q4 2017 and potentially $0.12 in Q2 2018; these were prospective considerations, not declared increases.
- Cain Brothers, a healthcare-focused investment bank, was acquired October 2, 2017, after quarter-end. Management anticipated approximately $20 million of related expense in its 2017 expense outlook.
- Risks include commercial credit concentration, deterioration in commercial real estate or regional economies, interest-rate and funding sensitivity, regulatory and compliance costs, litigation, cybersecurity and third-party operational risks, and the ability to realize First Niagara integration benefits. Management said the proposed CECL standard was expected to increase the allowance, but the amount had not been determined.
- Potential contingencies include guarantees with maximum undiscounted payments of $9.385 billion and recorded liabilities of $131 million; management assessed payment/performance risk as low. Other litigation outcomes remain uncertain. A checking-account overdraft case was ordered dismissed on October 27, 2017, after the reporting date.
Important facts for investors to verify
- Separate recurring earnings from acquisition effects, $48 million of First Niagara purchase-accounting accretion in Q3, merger costs, and the merchant-services gain and adjustment; review both GAAP and management’s non-GAAP reconciliations.
- Track loan growth and mix, especially C&I and commercial real estate exposures, and whether credit quality and charge-offs remain favorable absent the large Q3 recovery.
- Compare actual results with management’s 2017 revenue, expense, loan, deposit, and credit outlook; confirm the board’s subsequent dividend decisions and repurchase activity.
- Assess capital and liquidity trends, including the effect of share repurchases, debt issuance, regulatory changes, and the expected CECL allowance increase.
- Review subsequent filings for Cain Brothers’ acquisition accounting, final valuation adjustments for 2017 acquisitions, litigation developments, and any material change in guarantees or other contingencies.