KeyCorp (KEY) — Q2 2013 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2013; unaudited consolidated results. KeyCorp is a regional bank holding company operating primarily through Key Community Bank and Key Corporate Bank. Comparisons below are to Q2 2012 unless otherwise stated. Dollar amounts are in millions except per-share data and ratios.
Financial performance and condition
| Metric | Q2 2013 / June 30, 2013 | Comparable period |
|---|---|---|
| Net interest income (GAAP) | $581 | $538 in Q2 2012 |
| Net interest margin (taxable-equivalent) | 3.13% | 3.06% in Q2 2012; 3.24% in Q1 2013 |
| Noninterest income | $429 | $457 in Q2 2012 |
| Noninterest expense | $711 | $693 in Q2 2012 |
| Provision for loan and lease losses | $28 | $21 in Q2 2012 |
| Continuing-operations income attributable to Key common shareholders | $193; diluted EPS $0.21 | $217; diluted EPS $0.23 |
| Net income attributable to Key | $204, including $5 from discontinued operations | $236, including $14 from discontinued operations |
| Six-month operating cash flow | $946 | $373 in first half 2012 |
| Total assets / deposits | $90.6 billion / $67.7 billion | $86.5 billion / $62.2 billion at June 30, 2012 |
| Loans, net of allowance / allowance | $52.2 billion / $876 | $48.7 billion / $888 at June 30, 2012 |
| Long-term debt | $6.7 billion | $7.5 billion at June 30, 2012 |
| Capital ratios | Tier 1 common 11.18%; Tier 1 risk-based 11.93%; total risk-based 14.65%; leverage 11.25% | 11.63%, 12.45%, 15.83%, and 11.35%, respectively, at June 30, 2012 |
Q2 taxable-equivalent net interest income was $586 million. The quarter’s cash efficiency ratio was 69.06%; excluding $37 million of efficiency initiative charges, the adjusted ratio was 65.42%. Return on average assets from continuing operations was 0.95%, versus 1.10% a year earlier.
Six-month cash flows: investing activities used $1.626 billion, financing activities provided $792 million, and cash and due from banks increased $112 million to $696 million. Key reported a $9.9 billion liquid asset portfolio at June 30, including $5.9 billion of unpledged securities, and unused secured borrowing capacity of $15.0 billion at the Federal Reserve Bank and $2.9 billion at the Federal Home Loan Bank. The loan-to-deposit ratio was 84%.
Material changes versus comparable periods
- Q2 continuing net income attributable to common shareholders fell $24 million year over year. Higher net interest income and stronger trust, investment banking, and card income were offset by lower total noninterest income, higher expenses and provision, and higher income taxes.
- Noninterest income declined $28 million year over year, primarily reflecting lower lease income and gains and lower principal-investing gains. The prior-year quarter included a $31 million gain from early termination of leveraged leases.
- Loans grew: period-end continuing loans were $53.1 billion, up from $49.6 billion a year earlier; average loans increased 6.6%. Commercial, financial and agricultural loans drove much of the growth. Deposits also increased year over year.
- Credit indicators improved overall: nonperforming assets were $693 million, down from $751 million a year earlier; net charge-offs were $45 million versus $77 million. The allowance was 1.65% of loans, versus 1.79% a year earlier.
- Available-for-sale securities rose to $13.3 billion from $13.2 billion at June 2012. First-half other comprehensive loss was $194 million, chiefly reflecting unrealized losses on securities and derivatives; accumulated other comprehensive loss was $318 million at June 30, 2013.
Outlook, management commentary, risks and unusual items
- Management maintained its outlook for mid-single-digit loan growth in 2013, led by commercial, financial and agricultural lending, and expected average earning assets in the second half to remain relatively flat with Q2 levels.
- Management expected modest net interest margin pressure of 1–3 basis points per quarter in the second half of 2013, citing asset-yield pressure and higher liquidity. It also expected the allowance as a percentage of loans to decline as credit quality continued to improve.
- Key had realized $171 million of annualized savings through Q2 and remained on target for $200 million by year-end. It consolidated 33 branches during Q2 and incurred $37 million of quarterly efficiency initiative charges.
- Key acquired commercial mortgage servicing rights from Bank of America on June 24; the acquired rights recorded at quarter-end had an estimated fair value of $117 million. Key expected to acquire remaining rights and finalize the transaction in Q3.
- The Victory Capital sale closed July 31, 2013, after quarter-end. Key revised its estimated after-tax gain to $100–$115 million from $145–$155 million, citing higher client attrition during the consent process. The expected cash portion was $75–$90 million; the Board was to consider additional share repurchases.
- Key repurchased $112 million of common shares in Q2 under a Federal Reserve non-objection capital plan authorizing up to $426 million through Q1 2014. The quarterly common dividend increased to $0.055 per share.
- Key described the U.S. recovery as slow and reported that interest rates rose sharply in May and June. Risks include economic weakness, interest-rate and market volatility, credit deterioration, liquidity and funding access, regulatory changes, operational and cybersecurity events, and legal proceedings.
- Legal matters included an appeal in the Metyk ERISA case and a renewed motion to compel arbitration in the overdraft litigation. Management said it was too early to determine whether the overdraft matter could have a material adverse effect. Guarantees had $14.220 billion of maximum potential undiscounted payments and $145 million of recorded liability; management assessed payment/performance risk as low.
- New U.S. regulatory capital rules were approved in July 2013. Key expected to meet the fully phased-in requirements, but trust preferred securities are scheduled to phase out of Tier 1 capital beginning in 2015 and be treated as Tier 2 by 2016.
Most important facts for investors to verify
- Whether loan growth, deposit mix and NIM perform in line with management’s 2013 outlook, particularly given the expected second-half margin pressure.
- Whether improved credit quality persists, including trends in nonperforming loans, charge-offs, criticized commercial exposures and the allowance relative to loans.
- Whether the $200 million annualized efficiency-savings target is achieved, and how recurring expenses compare with restructuring and acquisition-related costs.
- The final Victory sale proceeds and gain, client attrition, and any resulting share repurchases; also completion and performance of the acquired servicing-rights transaction.
- Capital and liquidity effects of share repurchases, dividends, regulatory capital-rule implementation and any ratings-related collateral requirements.
- Developments in legal proceedings, guarantees and other contingencies, and changes in fair values of securities, servicing assets and other Level 3 positions.