KEYCORP annual report, FY2015

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KeyCorp (NYSE: KEY) — 2015 Form 10-K

Business context and period. This annual report covers the fiscal year ended December 31, 2015; fourth-quarter results are also summarized. KeyCorp is a Cleveland-based bank holding company with $95.1 billion in year-end assets. Its two principal segments are Key Community Bank and Key Corporate Bank. The company operated 966 branches and 1,256 ATMs across 12 states.

Financial performance and condition

  • Earnings: Continuing-operations net income attributable to Key common shareholders was $892 million, or $1.05 diluted EPS, versus $917 million, or $1.04, in 2014. Total net income attributable to Key, including discontinued operations, was $916 million, compared with $900 million.
  • Revenue and expenses: Taxable-equivalent revenue was $4.256 billion, up 3.5% from 2014. GAAP net interest income rose to $2.348 billion from $2.293 billion; noninterest income increased 4.6% to $1.880 billion. Noninterest expense increased 2.9% to $2.840 billion. Pre-provision net revenue rose 4.7% to $1.416 billion.
  • Margins and returns: Net interest margin (taxable-equivalent) declined to 2.88% from 2.97%. Continuing-operations return on average assets was 0.99% versus 1.08%; return on average common equity was 8.63% versus 9.01%. Cash efficiency ratio improved to 65.9% from 66.2%.
  • Loans and deposits: Year-end loans were $59.876 billion, up 4.3%; deposits were $71.046 billion, down 1.3%. Average loans grew to $58.6 billion from $55.7 billion, led by commercial lending. The year-end loan-to-deposit ratio increased to 87.8% from 84.6%.
  • Credit quality: Provision for credit losses rose to $166 million from $57 million, reflecting loan growth and lower recoveries. Net charge-offs were $142 million, or 0.24% of average loans, versus $113 million, or 0.20%. Nonperforming loans declined to $387 million (0.65% of loans) from $418 million (0.73%). The allowance for loan and lease losses was $796 million, or 1.33% of loans, compared with $794 million, or 1.38%.
  • Capital and liquidity: Common Equity Tier 1 was 10.94%; Tier 1 risk-based capital was 11.35%, total risk-based capital 12.97%, and leverage 10.72%. The liquid asset portfolio totaled $15.4 billion, and estimated Modified LCR was above 100%. KeyCorp had $2.7 billion in short-term investments at year-end.
  • Debt and cash flow: Long-term debt increased to $10.186 billion from $7.875 billion. Cash flow from operations was $1.131 billion; investing activities used $2.023 billion; financing activities provided $846 million. Cash and due from banks ended at $607 million, down $46 million from year-end 2014.
  • Shareholder returns: Common dividends totaled $0.29 per share for 2015, up from $0.25. Key repurchased $460 million of common shares during the year; open-market repurchases were suspended in Q4 pending the First Niagara transaction.

Material changes versus 2014

  • Revenue growth reflected higher loan balances and stronger fee businesses, including record investment banking and debt placement fees. Lower earning-asset yields drove the margin decline.
  • Commercial, financial and agricultural loans increased 11.6% to $31.240 billion; those loans rose to 52.2% of the portfolio from 48.8%. Commercial real estate loans were broadly stable at $9.012 billion.
  • Commercial Corporate Bank revenue increased 10.0%, but higher credit provision and expenses left its attributable income slightly lower. Community Bank attributable income increased 5.8%.
  • Assets under management fell 13.2% to $33.983 billion, primarily due to securities-lending client attrition and market declines, despite higher trust and investment-services revenue.
  • Long-term debt increased by $2.311 billion, alongside new senior debt issuance. Total shareholders’ equity increased $216 million.

Outlook, commentary, risks and unusual items

  • 2016 outlook: Excluding the pending First Niagara merger, management expected net interest income growth below 5% without higher rates, or 4%–6% with higher rates; noninterest income growth of 4%–6%; noninterest expense approximately flat (within plus or minus 2%); and average loan growth of 4%–6%. Management expected net charge-offs to remain below its 0.40%–0.60% long-term target range and the allowance-to-loans ratio to remain relatively stable.
  • First Niagara: KeyCorp agreed to acquire First Niagara for stock and cash, with stated consideration of approximately $4.1 billion based on the announcement-date share price. Closing was expected in Q3 2016, subject to shareholder and regulatory approvals. Integration, execution, approval and potential divestiture risks remain. Putative shareholder lawsuits sought to enjoin the merger.
  • Ratings and funding: Following the merger announcement, S&P and Fitch affirmed ratings but changed the outlook to negative; Moody’s placed ratings under review for downgrade. KeyBank paid KeyCorp $1 billion in dividends in 2015 and had $553 million of regulatory capacity for dividends without prior approval at January 1, 2016. Parent-company liquidity depends substantially on subsidiary dividends.
  • Credit and market risks: Commercial, financial and agricultural loans, commercial real estate and commercial leases represented about 74% of loans. Oil and gas was about 2% of loans; management reported higher sector nonperforming loans and charge-offs following commodity-price declines. The filing also highlights commercial real estate valuation/oversupply risks, low interest rates, regional economic weakness and borrower defaults.
  • Other risks and items: Risks include heightened regulation, cyber and third-party operational events, litigation, and model risk. 2015 included $61 million of merger-, efficiency- and pension-related charges. Commercial allowance methodology was enhanced in Q3, with no significant net impact reported. The company disclosed no material adverse effect expected from legal proceedings based on information then available, while cautioning outcomes could exceed reserves.
  • Fourth quarter: Continuing-operations earnings attributable to common shareholders were $224 million, or $0.27 per share, versus $246 million, or $0.28, in Q4 2014. Q4 provision was $45 million versus $22 million, and noninterest expense was $736 million versus $704 million.

Most important facts for investors to verify

  • Whether First Niagara received required approvals, closed on schedule, and delivered projected revenue, cost savings and integration benefits.
  • Whether higher commercial loan concentrations, oil and gas stress, and the rise in provision translate into further credit deterioration or reserve needs.
  • Whether net interest margin stabilizes and management achieves its 2016 growth and expense expectations, which exclude the merger.
  • Whether rating outlooks or reviews change and how debt maturities, subsidiary dividend limits and liquidity requirements affect funding costs and capital returns.
  • How merger costs, pension settlements, securities/other investment valuations and legal matters affect reported earnings and cash generation.

Audit: Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting; management also concluded controls were effective as of December 31, 2015.