KeyCorp 2010 Q2 Form 10-Q Summary
Business context and reporting period
KeyCorp is a bank holding company with Community Banking and National Banking businesses. This unaudited quarterly filing covers the three and six months ended June 30, 2010, with comparisons to 2009. The interim financial statements received an independent accountant’s review, not an audit. Education lending and Austin are reported as discontinued operations.
Financial performance and position
Amounts are in millions of dollars except per-share data and ratios.
| Metric | Q2 2010 | Comparable period / context |
|---|---|---|
| Net interest income (GAAP) | $617 | $569 in Q2 2009; up $48 |
| Net interest margin (taxable-equivalent) | 3.17% | 2.70% in Q2 2009; down 2 basis points from Q1 2010 |
| Noninterest income | $492 | $706 in Q2 2009 |
| Noninterest expense | $769 | $855 in Q2 2009 |
| Provision for loan losses | $228 | $823 in Q2 2009 |
| Net income attributable to Key common shareholders | $29; $0.03 per share | Loss of $390; loss of $0.68 per share in Q2 2009 |
| Six-month net income attributable to Key common shareholders | Loss of $67; loss of $0.08 per share | Loss of $926; loss of $1.73 per share in first half 2009 |
| Total assets / deposits / loans from continuing operations | $94.2 billion / $62.4 billion / $53.3 billion | At June 30, 2009: $97.8 billion / $67.8 billion / $67.2 billion |
| Long-term debt | $10.5 billion | $13.5 billion at June 30, 2009 |
Q2 income from continuing operations attributable to Key common shareholders was $56 million, or $0.06 per share; discontinued operations reduced common earnings by $27 million. For the first half, continuing operations attributable to common shareholders recorded a $42 million loss. Six-month cash flows were $1.553 billion provided by operating activities, $1.298 billion provided by investing activities, and $2.731 billion used in financing activities; cash and due from banks rose $120 million to $591 million.
At June 30, the allowance for loan losses was $2.219 billion, 4.16% of continuing-operations loans and 130% of nonperforming loans. Q2 net charge-offs were $435 million, or 3.18% of average loans. Nonperforming loans were $1.703 billion and total nonperforming assets were $2.086 billion. Capital ratios included Tier 1 common equity of 8.07%, Tier 1 risk-based capital of 13.62%, and total risk-based capital of 17.80%. Key reported a 93% loan-to-deposit ratio and an $8.7 billion liquid-asset portfolio, plus $13.8 billion in unused secured borrowing capacity at the Federal Reserve and Federal Home Loan Bank.
Material changes versus prior periods
- Q2 returned to common-shareholder profitability, driven mainly by lower loan-loss provisions, lower expenses, and improved credit trends. Provision declined $595 million year over year; net charge-offs fell $67 million.
- Q2 noninterest income fell $214 million year over year, largely because Q2 2009 included securities portfolio gains, a gain on exchanging common shares for capital securities, and a Lehman-related gain. Lower leased-equipment gains also reduced the comparison.
- Continuing-operations loans declined about 21% year over year, reflecting weak demand, client deleveraging, portfolio runoff, sales, and charge-offs. Available-for-sale securities increased to $19.8 billion from $12.0 billion a year earlier, as loan repayments and liquidity management supported purchases.
- Deposits declined to $62.4 billion from $67.8 billion year over year. The mix shifted away from higher-cost time deposits toward transaction and noninterest-bearing deposits. Long-term debt also declined.
- Nonperforming loans fell $362 million from Q1 2010. The allowance coverage ratio improved from 107% a year earlier to 130% at June 30, 2010.
- Adoption of new consolidation guidance brought education-loan securitization trusts onto the balance sheet from January 1, 2010, adding $2.8 billion of assets and liabilities and a $45 million after-tax increase to opening retained earnings. The trusts’ assets are restricted to settling trust obligations, with no recourse to Key for those obligations.
Outlook, commentary, risks, contingencies, and unusual items
- Outlook: Management expected Q3 2010 net interest margin to expand approximately 10–15 basis points from Q2, citing certificate-of-deposit repricing. Management anticipated further allowance reductions for the rest of 2010 if credit performance improved, while warning that a weaker economy could change that expectation. Long-term goals include a 90%–100% loan-to-core-deposit ratio, 40–50 basis points of net charge-offs, margin above 3.50%, and return on average assets of 1.00%–1.25%; these are goals, not a full-year earnings forecast.
- Credit and economy: Management described the recovery as fragile and the pace of growth as uncertain. Commercial real estate remained stressed; elevated vacancies, weaker rents, and falling property values could impair borrowers and collateral. Management said net charge-offs remained elevated despite recent improvement.
- Regulatory changes: The Dodd-Frank Act was signed July 21, 2010. Its future rules could affect capital treatment, derivatives, deposit insurance costs, debit interchange, and other activities. Key estimated annual debit-interchange revenue of about $75 million and anticipated Regulation E-related annual deposit-fee reductions of about $40 million based on opt-ins through July 30; both impacts remained subject to change and rule implementation.
- Capital and ratings: Trust preferred securities contributed $1.8 billion, or 14%, of Tier 1 capital; Dodd-Frank phases out their Tier 1 treatment beginning in 2013. Moody’s placed specified KeyBank ratings under review for possible downgrade in July 2010, citing government-support assumptions. A downgrade could raise funding costs, require collateral, and constrain liquidity.
- Liquidity and dividends: KeyBank could not pay dividends to its parent without regulatory approval at June 30. KeyCorp reported $3.3 billion of parent-company short-term investments to cover projected maturities over the next 24 months. KeyBank opted out of extending unlimited FDIC coverage under the TAG program for the interim period, but management did not expect a significant liquidity effect.
- Contingencies: Guarantees had maximum potential undiscounted payments of $14.484 billion and recorded liabilities of $204 million; management assessed payment/performance risk as low. Key disclosed a shareholder derivative suit concerning 2009 executive compensation, ERISA litigation, Madoff-related claims, and patent litigation. For the Heartland payment-card intrusion, KeyBank had received card-network assessments; possible net charges could be significant but were not quantifiable, and no reserve was recorded. Heartland reported a MasterCard settlement with aggregate payments capped at $41.4 million, subject to conditions.
- Other unusual matters: The filing describes fair-value volatility in the discontinued education-loan trusts and Level 3 valuation inputs. Key reported a $594 million net deferred tax asset from continuing operations and concluded it was more likely than not to be realized. No goodwill impairment was recorded in Q2.
Important facts for investors to verify
- Whether lower provisions and improving nonperforming assets continue, and whether the allowance remains adequate as charge-offs evolve.
- Whether Q3 margin expansion occurs as projected, and how loan runoff and reinvestment in lower-yielding securities affect recurring revenue.
- How Dodd-Frank implementation affects capital ratios, deposit-insurance assessments, derivatives, and interchange or overdraft-related income.
- Whether Moody’s review leads to a KeyBank rating action and whether that changes collateral needs or funding costs.
- The ultimate exposure from the Heartland matter and other litigation, guarantees, and off-balance-sheet commitments.
- How the education-loan trusts’ fair values and discontinued-operation results change; the filing identifies substantial unobservable valuation assumptions.