KeyCorp (KEY) 2004 Q2 法說會逐字稿

Good morning and welcome to KeyCorp's second quarter 2004 earnings results conference call.

This call is being recorded.

At this time I would like to turn the call over to the Chairman and Chief Executive Officer, Mr. Henry Meyer.

Mr. Meyer, please go ahead, sir.

Thank you, Operator.

Good morning and welcome to KeyCorp's second quarter earnings conference call.

We really appreciate you taking some time to be a part of our discussion.

Joining me for today's presentation is our CFO, Jeff Weeden, and we also have several members of our executive team available for the Q&A portion of our call.

I would ask you to turn to slide 2 which is our forward-looking disclosure statement.

As you know it covers not only our presentation but also the Q&A that follows.

If you would now turn to slide 3.

Before we begin our financial review I'd like to comment briefly on some of the strategic moves that we've made to strengthen our Company.

We continue to invest in human capital and acquisitions that improve our market share position, both within our footprint and in our national businesses.

On the human capital side I'm especially pleased with the new talent that we've been able to attract to the Company.

Our recent hires include Tim King, who joins us from Wells Fargo to be the President of our Retail Bank, Chuck Kyle, who joined us from Barclay's to be Key's Chief Credit and Organizational Risk Officer, and Bob Wagner, who came to us from Gartmore Managers to be President of Victory Capital.

These talented, high energy individuals bring a wealth of knowledge and industry experience to Key.

I think it says a lot about Key's ability to compete and win in the war for talent.

Key also announced two fill-in acquisitions during the quarter.

We will be adding 11 branch offices and deposits from Sterling Bank in the affluent high-growth Detroit suburbs and last month we announced the acquisition of EverTrust Financial in Everett, Washington, with 12 banking offices and approximately 550 million in deposits.

EverTrust will give us the number two market share in Everett and strengthens our position in the high growth I 5 corridor.

And last week we announced the acquisition of American Capital Resource.

This is the fourth real estate acquisition Key has made in five years as part of its ongoing strategy to expand its commercial mortgage finance and servicing capabilities.

All three of these acquisitions are consistent with our strategic goal of improving market share within our footprint and leveraging our strong position in our national businesses.

Now, just a few comments on our financial results.

Overall, we had a very solid quarter with stronger performance from our market sensitive businesses.

The real standout was the improvement in asset quality.

Our nonperforming loans declined to their lowest level since December of '99 and our outlook is for continued improvement.

I was encouraged by the growth in our commercial loan balances during the quarter, the increases came from a number of different industry sectors and across most of our franchise.

And finally, we maintained our strong capital position which gives us the flexibility to make acquisitions, repurchase shares, and pay dividends to our shareholders.

Now I'll turn the call over to Jeff Weeden for a more detailed review of the quarter.

Jeff.

Thank you, Henry.

I'll begin with the financial summary shown on slide 4.

We earned 58 cents in the second quarter compared with 59 cents in the first quarter and 53 cents in the period a year ago.

Revenue was impacted in the second quarter by the decline in the net interest margin.

However, we did see some encouraging signs of commercial loan growth in the quarter.

Noninterest income was a positive, up 15 million from the first quarter.

And as Henry mentioned, the improvement in asset quality was a real standout in the quarter with charge-offs declining for the sixth consecutive quarter and nonperforming loans down 133 million from the first quarter.

Turning to slide 5, the Company's net interest margin decreased by 17 basis points in the quarter from 3.74% to 3.57%.

The primary reasons for the margin decline were asset sales and maturing interest rate swaps as we repositioned the Company for rising interest rates.

Our expectation is for the net interest margin to be stable to slightly improving in the second half of the year.

During the quarter, we continue to reduce our interest rate sensitivity to rising rates and ended the quarter in a neutral position to a 200 basis point increase in rates over the next 12 months.

Our average earning assets increased 493 million in the second quarter.

Increases in commercial loans and short-term investments were offset by declines in average balances and consumer loans and securities.

We were particularly encouraged by the commercial loan growth we experienced during the second quarter.

Annualized average balances of commercial loans in the second quarter were up 8.1% when compared to the first quarter.

This growth was broad-based across the Company.

Average balances of consumer loans were down 11.5% on an annualized basis due to the sale of fixed rate home equity loans at the end of the first quarter and the sale of an indirect portfolio in the second quarter.

Both of these sales came from our consumer finance division within Consumer Banking.

In our retail banking division, average loan balances increased 7.5% on an annualized basis during the second quarter when compared to the first quarter of 2004.

Our total revenue, as shown on slide six, was down in the quarter due to the 17 basis point decline in the net interest margin.

Noninterest income was up $15 million from the previous quarter.

The improvement was primarily due to an increase in investment banking and capital markets income which was partially offset by lower income from loan securitizations and sales.

Turning to slide 7, our noninterest expense was down $9 million from the year ago period and up $20 million from the first quarter.

One-half of this increase from the first quarter was due to higher franchise and business tax expense.

As you may recall we had an accrual adjustment in the first quarter for franchise and business taxes of approximately $7 million.

The second quarter cost for this item is a more typical of our expected run rate.

The balance of the increased cost was associated with marketing, occupancy and computer processing.

Slide 8 highlights our asset quality trends.

Net charge-offs were down $7 million from the prior quarter and down $37 million from a year ago.

For the second quarter, charge-offs represented 67 basis points of average loans and outstandings.

As we mentioned earlier, we also experienced continued improvement in our NTL's and NPA's in the quarter.

NPL's declined 133 million from the first quarter to 0.71% of loans.

NPA's and NTA's declined 130 million from the first quarter to 0.84% of loans and ORE.

Compared to one year ago we have experienced a 357 million or 40% reduction in nonperforming assets.

Our loan loss reserve at June 30th represented 1.99% of loans and 281% coverage of nonperforming loans at quarter end.

Looking at slide 9, the Company's capital ratios are within our targeted ranges, specifically we target a tangible capital ratio in the range of 6.25% to 6.75%.

During the quarter we repurchased 6 million shares leaving 7 million shares available under our current board authorization.

We intend to continue to execute share repurchases in the coming quarters as a tool for managing our overall capital level.

And finally, turning to slide 10, we provide you with our third quarter and full year 2004 earnings outlook.

In the second half of 2004, we expect some growth in net interest income with a relatively stable to improving net interest margin and modest growth in loans and average earning assets.

The outlook for our fee-based businesses remains positive.

We would also expect continued improvement in asset quality.

Our expectation is for third quarter earnings to be in the range of 57 cents to 61 cents per share and full-year 2004 results to be in the range of $2.35 to $2.45.

That concludes our remarks.

And now I'll turn the call back over to the operator to provide instructions for the Q and A portion of the call.

Operator.

Thank you.

The question-and-answer session will be conducted electronically today.

Anyone wishing to ask a question may signal us by firmly pressing the star key followed by the digit 1 on your touchtone telephone.

We will take as many questions as time permits and will proceed in the order that you signal us.

As a reminder there may be many callers holding to ask a question at one time.

We appreciate your patience.

We'll begin with Jeff Davis, FTN Securities.

Good morning.

Good quarter.

Two-part question.

First, as it relates to reserves, and I know it's a moving target, but any sense on how far the drawdown in the dollar reserves might run?

And then secondly, if you could comment on loan demand on the commercial side differentiating among the regions.

Thank you.

Jeff, first of all, you're right, it is a moving target as far as what reserves may or may not be drawn down in future quarters.

I think we've had a very favorable experience here with the decline in nonperformers and the expectation, of course, is that if you saw some of the press release and the other information we provided, the fill rate of new non-accrual loans coming in has dropped significantly.

The expectation there is for additional decline in charge-offs as we look at the balance of this year, which may provide some degree of flexibility, if you will, with respect to having charge-offs exceed the levels that are provided.

I think I'll let Henry comment with respect to loan demand across the various regions.

Jeff, I talked to Tom Bunn just before this meeting and Tom indicated that loan demand is broad-based across all of the lines of business in KCIB, Key Corporate and Investment Bank, and across all geographies.

So while in the past we some -- we have reported some differences, we're really seeing some very encouraging signs across all of our geographies and across all of our different lines of business on the corporate side..

Does that -- Henry, if I could followup, does that -- does that change your thinking any with regards to the reserve releases going forward, that you may have to hold back some if the commercial side is getting ready to pick up significantly?

Well, just to follow on the comments that Jeff made, it is, Jeff, a dynamic process and clearly the balance sheet, credit quality, all of those are factors, and the best thing for KeyCorp and its earnings would be to see loan growth continue as our fee income has grown, and that's what we're hoping for, but crystal balls are less than perfectly clear.

Okay.

Thank you.

We'll take our next question from John McDonald, Banc of America Securities.

Hi, good morning.

Could you give us a little color on what some of the core consumer loan growth rates were ex some of the sales that you mentioned?

Yes, John.

In -- in my comments, if you look at specifically in the press release even, under the Consumer Banking and look down at retail banking you'll see that in the retail bank itself consumer loans grew at a 7.5% rate during the quarter.

We expect that, you know, we'll have continued growth in that particular line of business.

Those are primarily home equity loans throughout the retail franchise.

Okay.

And sorry if I missed this, Jeff, but do you have any other swap maturities that might impact the margin going forward that, you know, similar to what happened this quarter?

The future swap maturities, John, are going to be less dramatic than what happened in the second quarter.

The maturity that happened in the first quarter had a very wide spread on it.

Future maturities have narrower spreads on them and they're less material in nature.

Last quarter you had talked about maybe 5 to 10 basis points of margin compression this quarter turned out to be a little more than expected.

What was the difference?

The difference was we also sold a consumer loan portfolio, an indirect portfolio, here in the second quarter that had an impact on it plus we had a little bit of pricing pressure on the deposit side in the quarter.

As we were anticipating rates coming up we took an opportunity from competitive pressure to grow some of our deposit accounts.

Okay.

And your outlook for the second half is flat to slightly improving depending on commercial loan growth?

It's depending on commercial loan growth and also, you know, we've been very successful in retaining our DDA balances also, and the benefit associated with those particular balances in a rising rate environment.

John, this is Henry.

You'll remember that as we went into June, the speculation that the Fed was going to increase rates -- actually early in June there was speculation at 50 basis points, that affected the liability side, actually the whole yield curve moved, as you'll remember, but then we didn't get the benefit, we and other financial services companies, until the Fed actually moved on June 30th.

So there was a little bit of an imbalance between what we would normally consider equally rate-sensitive assets and liabilities and we'll see the benefit of the asset move from the June 30th prime in the third quarter.

Okay, thanks.

We'll take our next question from Joe Duwan, Fox-Pitt.

Oh, good morning.

I think you've answered one of my questions but the impact of the maturing swaps can you break that down in terms of basis point -- October 17?

Yeah, the impact of the maturing swaps was approximately 9 basis points in the second quarter.

Okay, thank you.

And then could you also elaborate on your investment banking revenues?

They were quite strong.

They were.

They were very -- they were quite strong.

We had good activity that happened in the second quarter.

The pipeline had a lot of activity during that particular quarter.

And we have a pretty full pipeline here as we head into the -- to the second, you know, or the third quarter here.

We're really seeing some of the early stages here of the increased M&A activity that's happening in the marketplace and we're participating in that.

Jeff, let me just add, this is Henry, that key's closed and been mandated on more lead managed equity transactions year to date than we've ever done in a full year.

So the focus that Tom Bunn has put on KCIB and the integrated 1 Key approach to middle market and upper middle market is really starting to pay off.

Okay, very good.

Thanks.

Our next question comes from KC Ambreck(ph), Millenium Partners.

Good morning, thanks for taking the question.

Just two things.

Could you just kind of address how much -- how low you're willing to take the reserve to loans and can you kind of talk about the negative operating leverage?

Well with respect to the loan loss reserve it's going to be dependent upon the overall risk assessment of the portfolio as well as other, you know, factors that go into it.

But it's -- as you look at what -- what we have for growth, we've had in the portfolio, what's the composition of the growth and the quality of the overall portfolio.

I don't think there's a specific targeted level that anyone can say that they're willing to pull down a reserve to.

As we look at -- I'm sorry, what was the --?

And then just the operating leverage.

Negative operating leverage.

That's going to show improvement here as we continue to have revenue grow into the future quarters here.

I think with the stability of the margin and an increasing balances that we'll have some growth on, we should see some improvement in our operating leverage as we look out into the future quarters here.

Do you expect to be positive?

Positive from -- yeah, I don't think we'll go further down at the level that we are.

We should migrate back down.

Our long-term goal is to get our operating leverage down to the mid 50 level.

So we have a lot of room left to go, obviously, from where we are now but that's the expectation is, that's the direction that we're heading.

I think we've done a very good job of controlling costs, our costs are down this year compared to last year and the issue that we have that we're dealing with is the margin is down this year compared to last year.

KC, this is Henry.

You know, we've said a couple of times that the loan loss reserve and adequacy is a dynamic process, really more words behind what that means is that we evaluate the adequacy of our loan loss reserve quarterly and we take into account all those factors that have been previously mentioned.

But it really is a process that is where we are at the spot that we're looking at and we try to do it as we come to a quarter end so that we know what our outlook on credit quality is as well as looking at the balance sheet and those other factors.

So we make those decisions not with a view towards we can take more down later on, we try to spot each quarter what the right level of the reserves is.

Okay.

I mean, I guess, you know, I think it was a good quarter, but I'm just trying -- we're just trying to understand kind of the core numbers here because the operating leverage is negative, you kind of bleeding the reserves, and it wasn't too long ago that, I think, KeyCorp took a charge to jack the reserves and now you're kind of releasing them back into earnings.

So, I'm just trying to normalize all this and really see what kind of the core run rate going forward is.

You've got to remember, Casey, as you look at our quarter-to-quarter and quarter to year ago that we have been pulling down reserves.

We did it for two years with a special reserve charges that I took when I became Chairman and we said that was the runoff portfolio.

But we are continuing to show better asset quality in our comparisons on stated EPS.

This is not the first time we have pulled down reserves and we're doing it now because of the significant improvement in asset quality.

Okay, great.

Thank you.

And at this time we are standing by with no further questions.

Mr. Meyer, I'll turn the conference back over to you, sir, for any additional or closing comment.

Thank you all for participating in our call.

Again, we think this was a good quarter, and we think the margin issue is now behind us.

As Jeff said, we're looking for stable to slightly improving as we go forward and I think the moves that we've talked about, i.e. that KeyCorp is really more market sensitive revenue oriented, and those areas are now starting to produce growing revenue and I think, again, the foundation is set for the third and fourth quarters.

So with that we'll sign off and thank you all.

Thank you.

And this does conclude today's presentation.

We do appreciate your participation.

You may now disconnect.