KeyCorp (KEY) — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; includes fourth-quarter results. KeyCorp is a U.S. bank-based financial services company operating through Key Community Bank and Key Corporate Bank. The year’s results include First Niagara from its August 1, 2016 acquisition date.
Financial performance and condition
| Metric | 2016 | 2015 |
|---|---|---|
| Net interest income, GAAP | $2.919 billion | $2.348 billion |
| Net interest income, taxable-equivalent | $2.953 billion | $2.376 billion |
| Net interest margin, taxable-equivalent | 2.92% | 2.88% |
| Noninterest income | $2.071 billion | $1.880 billion |
| Provision for credit losses | $266 million | $166 million |
| Noninterest expense | $3.756 billion | $2.840 billion |
| Income from continuing operations attributable to Key common shareholders | $753 million | $892 million |
| Diluted continuing-operations EPS | $0.80 | $1.05 |
Reported earnings were weighed down by merger- and pension-related costs. Key reported $483 million of such charges for 2016; its non-GAAP reconciliation identifies $465 million of merger-related noninterest expense and estimates the after-tax EPS impact of merger-related charges at $0.33. Excluding merger-related charges, diluted continuing-operations EPS was $1.13, a non-GAAP measure.
- Fourth quarter: Continuing-operations income attributable to common shareholders was $213 million, or $0.20 per diluted share, versus $224 million and $0.27 a year earlier. Taxable-equivalent net interest income was $948 million and the margin was 3.12%; the quarter included $92 million of First Niagara purchase-accounting accretion.
- Balance sheet at year-end: Total assets were $136.453 billion, loans $86.038 billion, deposits $104.087 billion, and long-term debt $12.384 billion. 2015 comparatives were $95.131 billion, $59.876 billion, $71.046 billion, and $10.184 billion, respectively; the First Niagara acquisition materially affects comparability.
- Cash flows: Operating activities provided $1.689 billion; investing activities used $6.457 billion; financing activities provided $4.838 billion. Cash and due from banks increased $70 million to $677 million. These flows reflect significant acquisition and securities activity.
- Liquidity and capital: The liquid asset portfolio was $24.2 billion, estimated Modified LCR exceeded 100%, and the loan-to-deposit ratio was 85.2%. KeyCorp’s Common Equity Tier 1 ratio was 9.54% under current rules and estimated at 9.43% when fully phased in; the Tier 1 and total risk-based capital ratios were 10.89% and 12.85%. KeyBank was reported well capitalized.
- Credit quality: Net charge-offs were $205 million, or 0.29% of average loans, versus $142 million, or 0.24%, in 2015. Nonperforming loans rose to $625 million (0.73% of loans) from $387 million (0.65%). The allowance for loan and lease losses was $858 million, 1.00% of loans and 137% of nonperforming loans, versus $796 million, 1.33%, and 206% in 2015.
- Returns and efficiency: Return on average assets was 0.70% and return on average tangible common equity was 7.39%, compared with 0.99% and 9.64% in 2015. The cash efficiency ratio was 73.7%, or 64.3% excluding merger-related charges; management’s long-term target is below 60%.
Material changes and notable items
- First Niagara added about $35.6 billion of assets and $33.0 billion of liabilities at acquisition-date fair value; consideration was approximately $4.0 billion. Key issued approximately 240 million common shares. The acquisition contributed substantially to reported balance-sheet, revenue, and expense growth.
- Key completed systems and client conversion in the fourth quarter, moving approximately one million clients and consolidating more than 100 branches. It also sold 18 Buffalo-area branches, including $439 million of loans and $1.6 billion of deposits.
- Commercial real estate loans increased to $17.5 billion from $9.0 billion, primarily due to First Niagara. Management identifies commercial real estate, commercial and industrial lending, and commercial leases as significant credit exposures. Oil and gas loans were approximately $1.1 billion; management said that portfolio performed in line with expectations, while charge-offs in commercial, financial, and agricultural loans increased.
- Common dividends totaled $0.33 per share for 2016, up from $0.29. Key repurchased $133 million of common shares under its capital plan, which authorized up to $350 million through the second quarter of 2017.
Outlook, risks, and contingencies
Management’s 2017 outlook excludes merger-related charges. It expected net interest income of $3.6–$3.7 billion, noninterest income of $2.3–$2.4 billion, and noninterest expense of $3.65–$3.75 billion. The outlook assumed one additional mid-year rate increase. Management anticipated average loan and deposit growth of 4%–6% after adjusting the comparison for a full year of First Niagara, and expected charge-offs to remain below its long-term target range of 0.40%–0.60%; provision was expected to slightly exceed charge-offs to support loan growth. The Board was to consider a possible quarterly common dividend increase to as much as $0.095 in the second quarter of 2017.
Key identified risks include credit deterioration, especially in commercial real estate and concentrated commercial lending; interest-rate and funding changes; integration execution and realization of First Niagara benefits; extensive regulation; cybersecurity and third-party operational failures; litigation; and model risk. The filing says acquired-loan fair-value estimates remained provisional at year-end. Management cited a $548 million estimated fair-value adjustment to the acquired loan portfolio and expected to finalize the valuation in the first quarter of 2017; related purchase-accounting accretion could change. Key stated that legal reserves were considered adequate and that proceedings were not expected to have a material adverse effect on consolidated financial condition, while cautioning that outcomes could exceed reserves or materially affect a particular period. A putative class action concerning overdraft practices remained in litigation.
Key facts for investors to verify
- Whether First Niagara integration delivers expected cost savings and revenue benefits, and how remaining integration charges compare with the reported $483 million of 2016 merger- and pension-related charges.
- The final acquired-loan valuation and its effects on goodwill, credit provisions, and future purchase-accounting accretion.
- Whether rising nonperforming loans, commercial charge-offs, and the lower allowance-to-nonperforming-loan coverage ratio persist or worsen.
- Whether 2017 revenue, expense, loan-growth, deposit-growth, and dividend expectations are achieved, including the rate assumptions underlying management’s outlook.
- Capital and liquidity after the acquisition and preferred-stock actions. The filing reports Series C preferred stock redemption in February 2017; investors should verify its completed cash and capital effects.
- Auditor and control status: Ernst & Young issued an unqualified opinion on the financial statements and internal controls, and management reported effective internal control over financial reporting as of year-end.