KeyCorp (KEY) 2005 Q4 法說會逐字稿

(CALL IN PROGRESS) Weeden and we also have several members of our executive team available for the Q&A portion of our call.

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

This statement covers both our presentation and the Q&A session that will follow.

Now if you turn to slide 3.

Key reported another good quarter with solid financial results and progress on our strategic priorities.

For the year Key earned over 1.1 billion or $2.73 per share which was the highest in the Company's history.

Return on equity for the full year 2005 was 15.4%, up from 13.8% the prior year.

I was very pleased with the continued growth in revenue, which benefited from higher net interest income and stronger results from our fee-based businesses.

Positives included solid commercial loan growth, higher core deposits, and a stronger net interest margin, even with rising interest rates and a relatively flat yield curve.

Key has also continued to strengthen its compliance practices, related to anti-money laundering and the Bank Secrecy Act.

We are aggressively implementing our master plan, including increasing support staff, adding new monitoring technology and enhancing employee training.

One of our highest priorities in 2006 is returning Key to being one of the top tier companies in regulatory compliance.

We have also continued to invest in our national businesses.

In December, we purchased the CMBS servicing portfolio of ORIX Capital Markets.

With this acquisition, Key is now one of the five largest commercial mortgage loan servicers in the United States with a servicing portfolio of over 70 billion.

Key's commercial mortgage servicing business now has approximately 2.2 billion in escrow deposits.

Last week, we announced the acquisition of Austin Capital Management.

This investment firm brings a new product line and a seasoned team of professionals to our asset management business, Victory Capital Management.

Finally, and I would ask you now to turn to slide 4, Key's Board of Directors yesterday approved an increase in the quarterly common stock dividend from $0.325 to $0.345 per share.

On an annualized basis this would bring our dividend to $1.38 per share for the year.

This is the 41st consecutive year that our dividend has been increased and that places us among a select group of companies in the S&P 500.

The Board's decision to increase the dividend reflects their confidence in the future direction of our Company.

Overall, it was a very solid quarter for Key in terms of both our financial results and the progress we have made on our strategic initiative.

Jeff will comment on our 2006 earnings outlook but let me just say that I was pleased with our performance in 2005 and feel that the Company is very well-positioned as we head into 2006.

Over the past several years we've continued to improve our risk profile, strengthen our management team, and focus on higher return relationship businesses.

I believe these actions will allow us to continue to deliver long-term value for our shareholders.

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

Jeff.

Thank you, Henry.

I will begin with the financial summary shown on slide 5.

We earned $0.72 per share in the fourth quarter versus $0.67 in the third quarter and $0.70 on an adjusted basis for the same period one year ago.

Our tax-equivalent revenue was up $52 million or 4.1% from last quarter, reflecting a four basis point increase in the net interest margin and a 1.4 billion increase in average earning assets.

Earning asset growth was driven by an increase in average total loans outstanding, resulting from improved commercial loan demand.

Average core deposits grew by 3.1%.

The growth into core funding and specifically non-interest varying deposits in a rising rate environment helped our net interest margin.

As we reported in our earnings release, we charged off 127 million of credit -- credits in our commercial passenger airline lease portfolio.

Excluding these charge-offs Key's net charge-off ratio for the fourth quarter was 22 basis points.

I will discuss our outlook for credit in a few minutes.

Turning to slide 6.

The Company's net interest margin increased four basis points from the third quarter to 3.71%.

As I mentioned, the improvement was primarily due to improved funding mix.

We have been successful in increasing our core deposits and the mix of these deposits over the past couple of years.

As Henry said earlier, we acquired the CMBS servicing portfolio of ORIX Capital Markets in December and now service more than 70 billion in commercial mortgage-backed securities.

Along with this portfolio come significant escrow deposits.

These deposits will help our margins in future periods.

Our current expectation for 2006 is for our net interest margin to be stable to improving from the fourth quarter level, given our slight asset-sensitive position to further increases in short-term interest rates.

On slide 7 you can see that Key's average loans grew by 1.3 billion or 2.1% from the third quarter of 2005.

Average loan balances were up 2.7 billion or 4.3% from one year ago's level.

The year ago comparisons are impacted by the transfer of certain consumer loans to a held for sale category in the fourth quarter of 2004.

The growth in the commercial portfolio during the fourth quarter was broad-based across all three major lines of business, specifically C&I, commercial real estate, and equipment leasing.

Average consumer loan balances remained relatively flat in the fourth quarter, as consumer preferences remained towards longer dated fixed-rate maturities versus the variable rate home equity product we retained for our portfolio.

Our expectation for 2006 is for loans to grow in the mid single digit range with commercial loans continuing to grow stronger than the consumer loan growth, given the shape of the yield curve.

Turning to slide 8.

Our fourth quarter average core deposit balances were up 3.1% on annualized compared to the third quarter and up 8.1% versus the fourth quarter of 2004.

We are pleased with the growth we have experienced in this area.

We believe our relationship pricing approach and the elimination of teaser rates late in 2004 have helped us grow and retain core deposits.

Also the growth we have experienced in our commercial mortgage servicing area has contributed to our increase in commercial DDA balances.

Slides 9 through 12 show our asset quality trends.

On slide 9, net charge-offs in the fourth quarter were 164 million or 98 basis points compared with 49 million or 30 basis points in the third quarter.

As I mentioned earlier, we charged off 127 million in the fourth quarter related to our commercial passenger airline leases.

Excluding these charge-offs from the total, net charge-offs represented 22 basis points of average total loans for the fourth quarter.

As we stated during our third quarter earnings call, these airline credits were already identified in our reserve analysis and, therefore, we did not replenish the reserve for the charge-offs taken on these credits in the current quarter.

Our remaining exposure to the passenger airline industry now stands at 86 million with less than 1 million categorized as non performing.

We currently expect net charge-offs in 2006 to be in the range of 30 basis points.

As shown on slide 10, NPAs at December 31st, 2005 represented 46 basis points of total loans and other real estate owned.

This is down 14 basis points from the third quarter and the level one year ago.

Turning to slide 11.

Our loan loss reserve at December 31 remained strong and represented 1.45% of total loans.

And on slide 12, our coverage ratio of our allowance to non performing loans stood at 349% at December 31, 2005.

Looking at slide 13, the Company's tangible capital to tangible asset ratio was unchanged from the prior quarter at 6.68% and is within our targeted range of 6.25% to 6.75%.

During the quarter we repurchased 3.25 million common shares, leaving 22.5 million shares available under current Board authorization.

We will continue to use share repurchases as a tool in the management of our total capital level.

Finally, turning to slide 14, which provides our first quarter and full year 2006 earnings outlook.

As I discussed earlier, our current outlook is for the net interest margins to remain stable to improving from the level we experienced in the fourth quarter.

We are also looking for mid single digit earning asset growth in 2006.

We anticipate low single digit expense growth in the current year and we look for credit cost to be in the range of 30 basis points.

Based on these assumptions, our guidance for the first quarter is for earnings per share to be in the range of $0.67 to $0.71 and for the full year 2006, earnings to the in the range of $2.80 to $2.90 per share.

That concludes our remarks and now I will turn the call back over to the Operator to provide instructions for the Q&A segment of our call.

Operator.

(OPERATOR INSTRUCTIONS) Brent Erensel.

Portales Partners.

A question on the timing of the aircraft lease charge as to why you took it now?

Second, prospects for recovery in that charge.

And third, dynamics of new NPAs that came on because NPAs didn't go down as much as you charged off in that regard.

Chuck Hyle will answer that particular question.

First to your airline question.

The fourth quarter saw a flurry of bankruptcies and obviously activity in that particular sector with rising oil prices (technical difficulties).

So we felt it was the right time to take those.

We had already, as Jeff indicated, provided for those particular airlines so we wanted to put that behind us.

In terms of prospects for recovery these are equity portions of leveraged leases so I think you can draw your own conclusions as to potential recoverability.

As far as other NPLs and NPAs in the portfolio, they did go up modestly in the commercial side -- very modestly -- and also on the consumer side but nothing particularly dramatic.

Can you characterize where they came from?

On the consumer side we did see a little bit of an uptick in bankruptcy activity for the quarter as most banks have pretty much across the board.

But again nothing terribly material in any of the consumer portfolios.

Commercial side?

Very modest.

Just a very little bit in the middle market.

Very small numbers here and there but again nothing particularly material.

Scott Siefers with Sandler O'Neill.

Just given the breadth of the footprint, I was just wondering if you could talk about both pricing on a kind of regionalized basis for loans and deposits and then any differences you are seeing in overall loan demand by region.

Tom Bunn will probably address the overall demand by region and growth that we are experiencing.

With respect to deposits, again, it's very competitive across the entire franchise with the Midwest I think you probably heard this very consistently from others as well as from us in prior quarters.

Deposit pricing in the Midwest is very competitive.

Remains competitive.

There are other parts of the country that we are able to raise deposits at less cost to us than what we can in this particular part of the country.

That's really where our franchise and our footprint benefits us quite nicely.

So I think I will let Tom address the issue on the commercial loan demand and pricing.

Pricing remains challenging.

I think we are seeing competition across every market on the lending side, both in the leasing business as well as the commercial loan business.

From a regional standpoint we continue to see very strong growth in the Northeast, in the Rockies, in the Northwest.

The Midwest had slowed and until last quarter was slightly up to flat between the Northeast Ohio region as well as the overall Midwest region.

Nancy Bush with NAB Research.

A question here on the margin.

I mean what is your -- what assumptions are you making for better margin in '06?

And what happens if the Fed sort of stops raising rates midyear?

Are you going to be able to hang onto the margin and continue to increase it?

Our spread -- net spread is still is somewhat under pressure.

I think if you look at what happened in the current quarter, the net spread was actually down two basis points.

We are getting a lot of our values coming out of our ability to increase our non-interest-bearing funding within the organization.

I think the ORIX Capital Market's transaction that closed in December will help by adding additional average balances to 2006 results on the DDA side.

So we are really seeing competitive pressures.

I think they've moderated some as far as they're not getting worse in the pricing department.

But the value that we see really relates to our non-interest-bearing funding and our ability to continue to grow that particular part of our funding mix.

With respect to when the Fed begins to (indiscernible) we've modeled out, just following the blue-chip forecast and then also using forwards and looking into the future and we remain slightly asset sensitive and our expectations are built into that but our range of stable to improving is based on all the assumptions that we have put into the model.

Henry, a question for you.

With a $1.38 dividend now and with your projection here is $2.80 to $2.90 for next year so roughly a 50% payout.

Can you just give us some idea what you are trying to manage the payout to?

I think we have been pretty consistent here in terms of 45 to 50% payout.

Our dividend through our transition years was above that 50% number and now that we are comfortably in that range, one could expect -- and again this is subject to the Board every year -- but our dividend increases would probably follow more closely to our earnings per share increases which, obviously, has not been the case over the last five years.

Matt O'Connor from UBS.

You had mentioned before that you are still a little bit asset-sensitive and as it becomes clear the Fed is about done, will you move to a neutral or liability-sensitive position?

That has always been our -- our strategy is to begin to shift our overall profile and protect ourselves against potential declining rates.

We have always felt that with an upward sloping yield curve that financial institutions make more money running the liability-sensitive position.

In a flat yield curve environment, that becomes more challenging obviously.

Our portfolios, as you know, on the commercial side were about 70% variable, on the consumer side we are about 50% variable rate.

So we benefited in this rising rate environment and then we have to again protect ourselves in the event that rates do come down.

So we will start on a reshifting the position of the Company over time.

And I assume that you are intending to do that this year.

Is that budgeted and planned?

I think what we -- we will manage our overall margin.

I think Joe Vayda who is our Treasurer -- he is actually in the room here, too -- but we are very much on top of trying to manage the overall margin.

And we will continue to synthetically shift the risk profile of the Company just because of the nature of our funds.

That's the way we end up managing it through the interest rate swaps.

And we will do that during the course of, probably, this year and into the next year.

And then unrelated should we assume that the provision expense matches charge-offs in '06?

I think you can look at our overall provision in charge-offs and use that as a reasonable assumption.

Again, it depends on the direction of non performing assets and credit quality, overall.

So there could be a time where provision is in excess of charge-offs.

There could be a time when it's below charge-offs.

I think you just have to look at it from this point on that that is as reasonable an assumption to use as any.

Maybe one last one for Henry.

Can you just talk a little bit about your M&A appetite and buys or deals you might consider?

Specifically in the banking space?

As I reported after the third quarter earnings release, we do have a regulatory consent order that we are operating under.

My hope is that we will in 2006, as early as is practical, get out from underneath that.

But that does eliminate expedited approval from the Fed.

So while the bid we offered the market still has a huge gap, we are not terribly active on the banking front right now -- which hasn't disadvantaged us because nobody really is.

We will continue to look for acquisition opportunities, including bank opportunities.

But our real focus over the next quarter or two will be getting out from underneath the MOU from the Fed and the cease and desist from the OCC.

But that doesn't mean that after we are out we are going to start.

Our regional executives as we moved to this new community bank are already talking to, contacting -- I honestly believe that acquisitions are [unnecessary] and will be a part of Key's future as we look over the next few years.

Christopher Chouinard.

Morgan Stanley.

I just had a couple of quick questions on some of the miscellaneous fee and expense items.

I was wondering if you could run through what was responsible for the uptick and miscellaneous other interest non interest income this quarter?

The increase we had more favorable gain on sale if you will of the disposition of some of our leases at the end of the -- or during the course of the fourth quarter, the end of the lease terms.

Other service charges, miscellaneous service charges were also up and some additional miscellaneous mortgage banking-related activities and fees that are incorporated into that particular line item.

That makes up the majority of that particular area.

So it is more of us a seasonal or more of just kind of a one-time bank -- it sounds like the lease can sometimes just be seasonal in the fourth quarter.

Well, it depends on market conditions.

I mean, you could run higher gains throughout.

So that's really pretty difficult to predict what will end up coming out at the termination of a lease.

The residuals are set obviously at the beginning of the lease time and market conditions dictate the gain or loss at the end.

But we've had pretty favorable, I think, consistently year end and year out.

It was just up in the fourth quarter.

On the expense side, can you talk about what were the costs of increased compliance as you are working to get out from underneath this MOU?

I think you can see from the professional fees in the fourth quarter they were up pretty significantly.

They were at 42 million, up about 13 million from the prior quarter and up 10 million from the year ago quarter.

So there's additional costs embedded in professional fees.

I would expect that professional fees will remain relatively high through the first half of 2006; and then I would expect that we will see improvement in that particular expense line item.

So that's driving.

I think we disclosed also in our press release that we put $15 million into the foundation in the fourth quarter.

We had a $10 million litigation settlement accrual that we had; and then we had an additional $5 million of costs associated with some of the closed schools in our educational lending area.

So that is really -- those last three items were recorded down in miscellaneous expense.

And that explains I think almost 100% of the increase quarter-over-quarter and year-over-year.

David Pringle from Hoefer & Arnett.

I didn't even know I'd gotten through here.

Do you have an update on this whole leasing issue with FASB and the Internal Revenue Service?

I think what we just saw were the Board -- staff advised the Board on Tuesday I believe of this week.

There was a release that came out.

This is still in discussion.

So I think it is premature for us to comment on the specifics surrounding it until we know what we are analyzing.

But, obviously, we are staying on top of it and we will monitor the activities associated with what they end up deciding.

And you guys bought -- do have any goals for what kind of share repurchases you are going to have on a quarterly basis?

Or is it more dependent on share price or what?

How do you look at it?

We manage the overall tangible capital ratio.

I think you've probably seen and we've talked about our stated objective, is to manage our capital, our tangible capital within a 6.25% to 6.75% range.

We are within that range.

We'll obviously look at our growth opportunities that we have within our franchise for organic growth and for acquisition growth.

And then we will manage that against share repurchase activity also.

Kevin St. Pierre from Bernstein.

Most of my questions have been addressed already.

I was just wondering if you could give us a little more insight as to in which period you provided for the aircraft charge-offs, the aircraft charge-off?

As I look back, we've seen seven or eight consecutive quarters now of declining reserves and reserved to loan ratios have been coming down for a number of years.

Just wondering in what period you provided for those?

I think if you were to look at 2001, you would see that there were special reserves and provisions that were taken at that particular point in time.

I think it was certainly something that after 9/11 in 2001 that there was indeed a concern about the liability of some of the passenger airline carriers.

It's just taken a little bit longer for that to play out but they've certainly been on our watch list if you will, for a period of time here.

And the final bankruptcies that took place in the fourth quarter and some of them going and completely liquidating on out with our equity positions we just charged those particular credits off.

Jeff Davis from FTN Midwest Securities.

Tom, could you comment on the commercial real estate borrowers in your lending efforts and your comments on regions that were previously made and may cover it but maybe by product type?

And what you're seeing as far as borrower strength and appetite or developer strength and appetite to continue going?

Is there a wariness in the market?

And just a little bit of an overview.

Sure.

You want the real estate as well as commercial or do you just want real estate?

Let's do commercial real estate.

The gist is are you've seeing any leading indicators that tell you that a hot market is going to slow significantly over the next four, six quarters?

I think the macro comment we would make is that we are very aware of the various regions in which we operate.

And one of the things we have built is it's diversified by product as well as diversified by geography portfolio and when you break down our portfolio,50% of our portfolio -- real estate portfolio -- is in the income properties group, which is the core commercial real estate business.

And it grew about 10% quarter-over-quarter and has been about 26% for the last 12 months.

That business is very geographically diverse and we have offices everywhere from Atlanta to Phoenix to L.A. to Cleveland, obviously, etc.

Our institutional group which is more the REIT business actually was up very little quarter-over-quarter, but up about 23% year-over-year.

It represents about 22% of our portfolio.

It is also very diversified but dealing mostly with a large cap, REIT businesses -- many of which are investment-grade and business that we have seen grow well following the hiring of Bill Hipp and his team 18 months ago.

The last piece is the homebuilder side, which has also grown substantially about 17% for the last quarter.

It only represents, though, 16% of our whole portfolio and that business, obviously, we are looking by region and being sure we keep an eye on with Chuck Hyle's people as to the local markets.

One of the advantages of the way we attack our markets is that we are there.

If we are lending in a market we are in that market.

We are physically in that market rather than parachuting in to make some loans in a market.

So I think that's an important point because we are -- we were early aware of the fact that we had to slow down in some of the condominium markets.

We tapped the brakes on some of those.

We'd rather not go through those specifically but we are going to continue to look at each individual market, each individual product, and be very aware of the local market conditions.

How big is the condo portfolio?

I think it's in the Q but I don't have it in front of me.

I'll have to come back.

That's okay, yes.

That's fine.

But the gist is, Tom, you're not -- the developers all of a sudden aren't showing fatigue and you've got signs that say, "This thing is going to dramatically slow down in the next four to six quarters."

I would make one other comment on our condominium portfolio.

A lot of what we do there are condominium conversions rather than new build, which have, obviously, we think a lower risk profile and a much shorter duration in that portfolio.

So, Tom, just to follow-up is, you are not seeing anything from your developers by region or by particular segment other than, maybe, some housing slowing down that says this commercial real estate engine is going to really slow in the next four to six quarters?

I think as we look into '06, so far our credit quality is very good.

And we do not expect the type of growth we have had over the last 12 to 18 months for the portfolio.

I think that everybody around the table would agree with that.

We expect, though, real estate to continue to be a strong performer in our portfolio.

May I ask one follow-up?

It is on, now, on the C&I side.

Is there a side from the auto sector?

Is there anything out nationally or within your regional footprint that you really want to avoid?

And secondly is there -- are there up-and-coming areas or industry groups that you are not in that are going to get resources?

From the Commercial and Institutional lending business, we feel very good about our geographic diversification and our commercial bank.

As I talked about.

If you look at our portfolio in the commercial banking side, only 33% of that portfolio is in the Midwest. 21% is in the Northeast and 17% is in the Northwest.

That makes up a large majority of the portfolio.

That business continues to churn along very well and we look at that as sort of a core product that will continue to be accretive.

In the institutional side -- which is a much smaller portfolio about $4 billion total -- we are in really about seven industries we are continuing to look at those industries and being more focused in those industries rather than broader in those industries.

So I think you'll not see us enter any industry verticals that we are not already in.

And in fact, you will see us continue to get more and more focused in the large cap institutional side.

Nancy Sexton from Addis Capital.

I have two questions.

First of all on the commercial loan growth can you tell us whether there were any large syndicated loans impacting that growth?

My second question, on the commercial non-performing assets, I want to make sure I'm looking at the correct numbers.

Without leases it looks like commercial non-performing assets went up by about 25%.

Does that sound right?

This is from third quarter '05 to fourth quarter.

Third quarter of '05 to fourth quarter, I think without leases you can say that there was a $9 million increase in commercial.

Commercial and commercial real estate.

Yes commercial -- that commercial and real estate went up $9 million, commercial went up 13.

So between the two of them, there's $22 million increase in nonperformance between the third quarter and the fourth quarter of this year.

Commercial real estate you'll see is down from a year ago in the nonperformance.

Right.

I'm just looking third quarter to fourth quarter.

It comes to about a 25% increase.

Yes you can say (MULTIPLE SPEAKERS) off of a low base it's off of a 60 -- I guess overall, not the it's off a pretty large base, when you look at 45 while excluding the leases, etc.

It is off a very large piece of activity.

There's about 35 billion in the total loan portfolio.

So we would view that as pretty nominal.

That's fine.

Just 25% increase to me is more than a modest increase even though it's coming off a low base.

And it was further concerning because all of the other banks in your market area in Ohio and Michigan have been reporting pretty sizable increases in non-performing assets so I was curious about that.

It's pretty widely spread across (MULTIPLE SPEAKERS).

We only have one loan over 10 million and that's an NPL.

How about on syndicated loans?

Unlike a year ago where we talked about a single transaction, there's not any single transaction that drove our assets quarter-over-quarter or year-over-year.

(OPERATOR INSTRUCTIONS).

And we have no further questions at this time.

Ladies and gentlemen, we again appreciate your participating with us in this conference call.

This was a very good year for Key.

We have good momentum as we go into 2006 and we look forward to talking with you all again in April after what I hope will be a good quarter again.

Thank you all and have a good day and a good weekend.

This does conclude today's conference.