KeyCorp (KEY) 2005 Q2 法說會逐字稿

Good day, everyone, and welcome to KeyCorp's second quarter 2005 earnings results conference call.

This call is being recorded.

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

Please go ahead, sir.

Thank you, Operator.

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

I know this is a busy day for conference calls, and we appreciate you taking the time to be a part of our discussion.

Joining me for today's presentation is our CFO, Jeff Weeden.

We also have several members of our executive team available for the Q&A portion of our call.

Slide 2 is our forward-looking disclosure statement which covers both our presentation and the Q&A session that will follow.

Now if you would turn to Slide 3.

Before Jeff reviews our results, I want to provide some overview comments on the quarter and the progress that we've made on our strategic priorities.

Overall, I was very pleased with Key's second quarter results, which reflected improved operating performance and the positive effects of our longer term strategic actions.

Tax equivalent revenue was up $67 million compared to the second quarter of last year.

The increase was due to higher net interest income driven by strong commercial loan growth and an increase in core deposits.

Asset quality also continued to be a very positive story.

Nonperforming loans decreased for the 11th consecutive quarter, and the net charge-off ratio was at its lowest level since the fourth quarter of 1995.

These positive results reflect the strategic actions we've taken to improve our business mix and credit risk profile.

During the second quarter, we completed our previously-announced sale of our indirect auto business.

As I have reported, this business did not meet our desired risk-adjusted return profile.

In the first quarter of this year, we sold 1 billion of prime auto loans, and in April we sold the remaining 600 million of non-prime loans.

We will, however, continue to build our commercial finance business with auto dealers, i.e., the floor plan business.

We have now completed the exit from our retail indirect auto business.

The integration of American Express' small ticket leasing business into Key Equipment Finance, which closed in December of last year, has also gone extremely well.

This acquisition added 1,000 new vendor relationships, 50,000 new clients, and combined with Key's existing operation, created one of the largest small ticket leasing businesses in the United States.

Key Equipment Finance is presently the third largest bank-based equipment leasing company, managing a portfolio of approximately $10 billion.

Last month Key announced the acquisition of Malone Mortgage Company in Dallas, Texas.

This was our fifth acquisition in five years in our commercial real estate business, KeyBank Real Estate Capital.

Malone Mortgage will strengthen our financing and servicing capabilities to our commercial real-estate developer clients across the U.S.

KeyBank Real Estate Capital is the nation's third largest provider of commercial real estate capital, with nearly 19 billion in annual financings.

We have also built our commercial real estate servicing portfolio to be approximately $40 billion, which also brings with it over 1.2 billion in commercial deposits.

With those brief comments, I'll now 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 $0.70 per share in the second quarter, up 20.7% from the $0.58 we reported in the second quarter of 2004, and up from the $0.64 we earned in the first quarter this year.

Our return on equity increased to 16.15% for the second quarter from 13.97% for the same period last year.

As you may recall, our long-term goals are to grow our earnings 8 to 10% per year and achieve a 16 to 18% return on equity.

Our tax equivalent net interest income was up $72 million from the same period one year ago, reflecting a 15-basis-point increase in the net interest margin and a 6.6% increase in average earning assets due to strong commercial loan growth.

Asset quality continues to improve, and we experienced a 7.9% growth in average core deposits compared to the second quarter of last year.

Slide 5 compares our second quarter results to the same period of last year and the first quarter of 2005.

As you read in our press release, we have reclassified on our balance sheet operating leases from loans to accrued income and other assets for all periods presented.

With respect to the income statement classification, rental income and depreciation expense associated with these leases were reclassified from net interest income to other income and other expense.

While this changed where we reported the income and expense, the reclassification had no impact on net income for any periods reported.

Turning to Slide 6.

The Company's net interest margin increased 5 basis points in the quarter to 3.71% from 3.66% in the first quarter.

During the second quarter, the net interest margin benefited from a principal investing distribution of $15 million received in the form of dividends and interest.

This added approximately 8 basis points to the net interest margin for the current quarter.

Without this benefit, the net interest margin would have been 3.63%, or down three basis points from the first quarter.

We expect that our net interest margin will remain relatively stable in the low 3.60 range for the balance of the year, given our slight asset-sensitive position to further increases in short-term interest rates.

Moving to Slide 7.

We continued to experience growth in our average balances in our commercial loan portfolio in the second quarter due to strong growth results in our commercial real-estate area, as well as middle markets.

Average balances of commercial loans were up 878 million, or 2% when compared to the first quarter.

Within our Corporate Banking division, we experienced good growth in our middle market areas across the entire Company.

However, this growth was offset by paydowns in our institutional divisions.

Average balances of consumer loans decreased by 1.3 billion in the quarter due to the sale of the indirect auto portfolios completed in March and April.

Excluding loans held for sale, average balances of consumer loans decreased 165 million in the quarter.

This decrease appears to be the result of a flat yield curve with consumers choosing to refinance in the longer-term fixed rate loans which are placed into the secondary market.

Year-over-year, average loans were up 8.3%.

Our expectation is for upper single-digit commercial loan growth and relatively flat to low single-digit consumer loan growth for the balance of the year.

Turning to Slide 8.

Our second quarter core deposit balances were up 2.5% unannualized compared to the first quarter and up 7.9% versus the second quarter of 2004.

Slides 9 through 12 show our asset quality trends.

On Slide 9 net charge-offs in the second quarter were 29 basis points of average total loans compared to 32 basis points last quarter and 67 basis points in the second quarter of 2004.

As you can see, charge-offs have come down significantly over the past several years.

Our long-term, over-the-cycle target for charge-offs is in the range of 50 to 55 basis points.

Our expectation for charge-offs in 2005 is to be in the low 30-basis-point range.

Slide 10 is our trend in NPAs.

At June 30th, 2005, NPAs represented 50 basis points of total loans and other real estate owned.

NPLs represented 43 basis points of total loans at June 30th, 2005.

Turning to Slide 11.

Our loan loss reserve at June 30th represented 1.62% of total loans.

And on Slide 12, our coverage ratio of our allowance to nonperforming loans stood at 375% at June 30th, 2005.

Looking at Slide 13, the Company's tangible capital ratio is within our targeted range of 6.25% to 6.75%.

During the quarter, there were no repurchases of common shares.

Our current Board authorization for repurchases remains at 27 million shares.

And we will continue to use share repurchases as a tool in the management of our total capital levels.

Now turning to Slide 14.

This provides our third quarter and full-year 2005 earnings outlook.

Our plans still call for single-digit -- mid-single-digit loan and earning asset growth in 2005.

As I said earlier, we would expect the net interest margin to be in the low 3.60 range.

We also expect credit quality to remain relatively stable with the current levels that we've been incurring in the first half of the year.

Our guidance for the third quarter is for earnings per share in the range of $0.64 to $0.68, and for the full-year EPS to be in the range of $2.60 to $2.70.

That concludes our remarks, and now I'll turn the call back over to the operator to provide instructions for the Q&A segment of our call.

Operator?

Thank you. [OPERATOR INSTRUCTIONS] We'll begin with John McDonald of Banc of America Securities.

Good morning.

Question for Jeff.

Thanks for the detail on the guidance.

One additional question.

How much reserve relief do you build into the outlook for the third quarter when you give the full-year guidance range?

Are you assuming kind of a matching provision to charge-off or is there some reserve relief baked in there?

John, my assumption is that, based on the way we forecast, we are not anticipating any reserve release at this time.

Of course, we go through the computation each and every quarter and have to build up the reserve adequacy based upon the facts and circumstances that exist at that particular point in time.

Okay.

And then maybe for Jeff or Henry, you could comment on why there weren't any buybacks this quarter.

And just in general, it seems like your capital levels are high.

Could you talk about opportunities for additional acquisitions and how you're looking at the use of capital going forward?

Well, I'll comment on the capital level and the reason we didn't have buybacks in the current quarter.

We're within our targeted range, John, of 6.25 to 6.75 at a 660 on a tangible capital ratio.

That's what we try to manage towards.

We've built a little bit of capital.

Obviously we've had acquisitions we've conducted in the past.

And we continue to look at opportunities in the future.

So just keeping our powder a little bit dry, if you will, to look for other opportunities to expand the franchise.

John, this is Henry, I might just add that we continue to have a very disciplined approach to acquisitions, the fact that Malone Mortgage was in there, and there's nothing that should be read into the stock non-buyback in the second quarter.

We use stock repurchases, as Jeff said, as a capital management tool, and we're also looking for the right opportunities to add to the business mix as we've shown over the last few years.

So nothing should be read into that.

Sure.

Henry, any change in the outlook for bank acquisitions in terms of the number of opportunities that you look at or the pricing?

Has it gotten any more reasonable?

You've talked about that being high.

No, I would tell you, that like every other financial services company, we are talking to and trying to cultivate, but I would continue to say that the reason more deals aren't being done is that the spread between bid and asked is undisciplined, and there is still a feeling that if you hold out, you can get 3.5 times book.

And many of the disciplined buyers, and I would include us as one of those, find it very difficult to reward our current shareholders with those kinds of prices.

Thanks.

We'll go next to Kevin St. Pierre of Bernstein.

Good morning.

Just a little more on the reserves.

Although the reserve ratios and coverage ratios to NPAs and annualized charge-offs are improving quarter to quarter sequentially and for several quarters now, and that's quite good, the reserve to loan ratio obviously has been trending downward as NPAs and charge-offs decline.

I was wondering if you thought there was a floor somewhere or where do we go, in theory, if we see non-performers having troughed, or increasing going forward, we could have conceivably introduced more volatility into the income statement.

Just wondering where you think we can go on reserve to loans and what your guidance going forward considers in terms of non-performers.

Well, I believe that as an industry, that's one of the things that the external environment actually looks at anymore, is there will be more volatility in earnings as a result of the business cycle going forward.

We are at a 1.62% of reserves to total loans.

I think that still places us at the top of the peer group as far as overall reserves to loans.

We feel very comfortable with our reserve levels that we have established.

Again, we go through a pretty elaborate process as we build up our reserves, and eventually, when we see non-performers start to turn around and we see the criticized classified trends, et cetera, start to increase, those particular trends, that will build into the formulas that are developed for the overall reserves and necessitate some changes in the direction of the reserve.

I think as you look, credit quality has been getting better, the direction of the reserves have been coming down, but they're still, in the case of KeyCorp, very, very adequate.

And in the second half, in the 2.60 to 2.70, are you anticipating stable credit, stable non-performers, and such?

That is correct.

Okay.

Thank you.

And just on the deposit growth trends, if I look at period-end balances, you had some strong growth in non-interest-bearing accounts, but most of the growth, in dollar terms, has come in higher costing categories, maybe you could comment on the competitive environment, what's happening in the market for deposits.

Well, the overall market is very competitive for deposits.

Of course, one of the benefits that we have at Key, we've -- you've heard in the past that it's also sometimes viewed to be a detriment, but the geography, the fact that we're spread across the United States, there are different areas of the country that are more rational in some of their deposit pricing than other parts, but we have remained very disciplined in our pricing approach.

We will compete in the marketplace for deposits, as well as we compete for loan opportunities, lending opportunities, but we have experienced I think what you noted was we did have very good growth in the transaction, the DDA balances were up in the quarter.

Now in money market accounts we also had expansion in, but it varies, Midwest is probably the most competitive, then the Northeast, with the West and the Rockies being more rational in their pricing.

Thank you.

We'll go next to Chris Chouinard with Morgan Stanley.

I just had a question, I wanted to follow up on something you had mentioned about consumers sort of locking in fixed rates, I guess, because of the flat yield curve.

Were you talking about that in relation to your home equity loan growth, which seemed a little bit weaker this quarter?

Is that where you're seeing the trend?

Yes.

What we're seeing is the consumer preference is really to go out longer on the yield curve because of the home equity lines of credit are priced off of prime, which has been moving up, it's actually been more advantageous for consumers to move out further and get actually a lower rate than what they can get on a home equity line of credit.

So the demand in the home equity line of credit area has been relatively soft in the first half of the year.

We did see a little bit of an improvement in the second quarter versus the first, as far as demand goes, but again, the turnover in that particular area, we think that there's still more consumers moving out on the yield curve.

I see.

And if I could just get also a little more color on that -- the benefit you had this quarter from that principal investment, just, when that investment was made and kind of some of the -- maybe some of the details, and if this is part of a recurring stream?

Will we be getting this next quarter or how often do you get these types of benefits from these investments?

We get benefits from principal investing virtually every quarter.

Depends on the business cycle.

Sometimes we get detriments from that particular area also.

I think if you look at some of the other line items in fee revenue, you'll see that gains from principal investing this quarter were $1 million versus 12 million the prior quarter and 19 million in the year-ago period.

So you basically -- it's geography of where it was recorded.

Had it been recorded in other income, it would have been $16 million of gains compared to 12 compared to 19.

So I think you can see the reoccurring nature of it.

The other part I would point to, if you look at line -- Page 7 of the press release, for example, under "other segments" you'll see that there's $10 million of net income that was derived from treasury as well as principal investing activities.

Basically half of that $10 million of profit for the quarter came from the principal investing area, so it contributed about $0.01, compared to a year ago it would have contributed approximately $0.02.

Chris, this is Henry.

The only thing that was a little bit unique about this past quarter was the form, because of investment and a spin-off, and then the way we were paid, which classified it as dividend and interest, but as Jeff has pointed out, we're in the principal investing business over the past years, we've taken some hits.

It's a recurring, it's a normal business.

It was just captured on a different line, and I think that was pretty unique.

I don't think we'll see that happen often.

Got it.

Thank you very much, guys.

We'll go next to Mike Mayo of Prudential.

I just want to make sure I understand the margin guidance.

You said you expect kind of low 3.60s for the year, and optimally it's like 3.71 now.

So should we expect lower margins in the third and fourth quarter versus the second quarter, or am I misunderstanding something?

Mike, this is Jeff Weeden.

In our guidance we've given, we said low 3.60s, on an adjusted basis we're at 3.63 for the second quarter.

So you're talking on an adjusted basis?

On an adjusted basis, right.

Versus the 3.71.

Again, the principal investing activity added 8 basis points, so the margin percentage on a reported basis, the expectation would be it would come down in the third and the fourth quarter compared to the second, but on an adjusted basis, it should be relatively stable, in that range.

And you expect it to be stable why?

Well, we're in the asset sensitive position.

We have experienced -- if you look at what we would have had with just the held for sale loans that rolled off on the auto portfolio, the expectation would have been it would have come down up to the -- the yields would have come down up to 10 basis points just as a result of that particular transaction, which would have impacted the margin.

We've had growth in our non-interest-bearing funding, our DDA balances were up, and that contributed about 7 basis points to the net interest margin in the second quarter versus the first.

Can you talk about deposit and loan growth and competition by region, your nice snapshot on a few different areas of the U.S.

Yes, I think what I'd ask maybe Tom Bunn to comment just briefly on what he's seeing in the growth side on the commercial, as well as the competition.

Sure.

Hi, Mike.

Hey, Tom.

In the commercial side, we've seen loan growth across every region, which we're very pleased with.

This is not the first quarter we've seen that.

We've seen that as a trend.

The Midwest, the Northeast, the Northwest, the Rockies all saw mid to upper mid single-digit growth quarter over quarter.

So middle market.

That's commercial loan growth.

We're also seeing -- in real estate we've seen 8% growth quarter over quarter as well.

So our core businesses are showing good asset growth.

And in the real-estate business that business is spread across all the major segments of real estate.

So the granularity of our growth, both in the commercial side and in the real estate side is good and steady.

Jeff, you want to do the deposit side?

On the deposit side, Mike, again, the Midwest is the most competitive market that we operate in, and then the best, from a competitive standpoint, is in the West.

And because of our relative size and everything in the West, we are able to offer attractive deposit rates out there and capture good growth in those particular markets as to what we believe is a very reasonable cost to the franchise.

And last question I guess for Henry, where you stand with regard to big deals, as far as merger of equals or anything like that, especially in light of some more recent consolidation.

Mike, as you probably are aware, we have nothing to report there.

You know, Mike, people are continuing to talk when good deals make sense for both shareholders, things will happen, and I'm not sure that big deals are being priced any differently than the small deals, which is why not much is happening.

There's discussions going on everywhere, but I don't think anything is close to popping, at least it isn't here at Key.

What geographies are of greater interest for you?

We continue to look at fill-in acquisitions.

We continue to want to improve our market share in those markets where our market position is either below 10% of the market or below the number four position.

And that encompasses really East to West.

There's no specific, you know this is the only place we'll look, as I think, Mike, you're aware, last year we did EverTrust in Everett, Washington.

We also did 10 or 11 branches from Sterling Bank and Trust just outside of Detroit, which is in the Midwest region.

So we continue to be on the lookout.

All right.

Thank you.

[OPERATOR INSTRUCTIONS] We'll go to Gerard Cassidy of RBC Capital Markets.

Can you guys talk to us about what you might expect to see in terms of consumer delinquencies when the new bankruptcy law takes place in October?

Are you guys seeing any indication that they may be picking up?

Well, Gerard, we're not seeing an increase in our delinquent loans.

As a matter of fact, as we look at our past-due credits, they've remained very stable to slightly improved here even in the second quarter, down from the first quarter.

There's always the possibility that you would have an increase, but I think we look at the type of credit that we have at this juncture.

We've sold out of our auto credit.

We have a prime portfolio in the -- in our home equity line of business, very strong FICOs, very good, you can see in the press release what the loan to values are, you can also see the number of first lien positions that we hold.

So that's the bulk of our consumer related lending, and then we have, of course, some of the indirect businesses still that we have in the marine financing, for example.

But we're not seeing an increase at this juncture, and we're not anticipating any significant movements other than just normal seasonal-type activity.

Thank you.

Then the other question I had was on the trust and the brokerage assets, the data you gave us, the non-managed and brokerage assets, they looked like they were 57 billion at the end of the quarter, down from the 61 billionish in the first quarter.

Can you give us some color on what attributed to the decline there?

Well, we have, I think there was an announcement we did sell an office location over in the Indianapolis area to another firm during the second quarter, as well as we've had some folks convert over to the bank-based product, too.

So it's primarily driven by the sale of an office, as well as some -- just I think normal activity and moving into bank products.

Thank you.

And, gentlemen, at this time, there are no further questions in the queue.

I'll turn the conference back to you for any additional remarks.

Thank you, Operator.

Again, as I said, we know this is a busy day.

We appreciate all of you taking time to be a part of our earnings conference call.

And with that, Operator, we'll adjourn our part of the meeting.

Thank you.

That does conclude today's conference call.

We thank you for your participation.

You may disconnect at this time.