KeyCorp (KEY) 2006 Q2 法說會逐字稿

Good morning and welcome to KeyCorp's second-quarter 2006 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.

Please go ahead, sir.

Thank you, operator.

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

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

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

Also joining me for the Q&A portion of our call, our Vice Chairs, Tom Bunn and Beth Mooney and our Chief Risk Officer, Chuck Hyle.

I would like to turn your attention to Slide 2, which is our forward-looking disclosure statement.

This statement covers not only our presentation but also the Q&A session that will follow.

Now if you turn to Slide 3.

Let me start with a few comments on our financial results.

Overall, it was a very good quarter for Key.

Our improved performance was driven by solid revenue growth and positive asset quality trends.

Compared with the second quarter of last year, tax equivalent revenue was up $90 million, due primarily to solid commercial loan growth, higher income from our fee-based businesses and growth in core deposits.

The growth in fee income was broad-based and included increases in trust and investment services, investment banking fees, net gains from principal investing and a $9 million gains from the MasterCard IPO.

Asset quality also remained solid.

Nonperforming loans and net charge-offs were down from the first quarter of 2006 as well as the year-ago period.

For the second quarter 2006, the net charge-off ratio was 21 basis points.

We have also continued to strengthen our management team.

In May, Beth Mooney joined us as Vice Chair of Community Banking.

I'm very excited to have Beth on our team, especially with the experience and leadership that she brings to her new role.

Over the past year, we have also appointed four regional presidents and significantly upgraded management talent in our 23 districts.

The last point on Slide 3 deals with regulatory compliance.

I'm very pleased with our continued progress on improving our systems and processes related to ante money laundering and other compliance controls.

Over the past year, we have invested heavily in technology and human capital with a goal of returning Key to being a top tier company with respect to regulatory compliance.

The progress that we have made is attributable to those significant efforts of our entire organization, and especially those in the compliance area, who have taken a leadership role in making sure that we meet or exceed the new regulatory requirements.

Turning to Slide 4, this shows our current organizational chart.

Those of you who have followed our Company for a number of years will recognize that four out of five of my direct reports are new to the Company since 2002, including Tom Bunn and Beth Mooney, who head up our two major business groups.

With the addition of Beth, this completes the rebuilding of our executive leadership team.

I am extremely pleased with the extraordinary talent that we have been able to attract over the past five years and the leadership that is now in place to grow the Company.

With those brief comments, I'll now turn the call over to Jeff for a more detailed review of the quarter.

Jeff?

Thank you, Henry.

I'll begin with the financial summary shown on Slide 5.

We earned $0.75 per share in the second quarter versus $0.70 in both the first quarter and the same period one year ago.

Our tax equivalent revenue was up $90 million or 7.4% from the year-ago period.

Net interest income increased 29 million and fee income was up 61 million.

Fee income benefited from improved principal investing results and overall increase in a number of fee-related business activities and a gain recognized on the MasterCard IPO.

Earning asset growth was driven by an increase in average total loans outstanding.

Average total loans grew by 4.6% from the year-ago period.

Commercial loans increased by 7.8% and consumer loans declined by 2.3%.

Average core deposits grew by 10.2% compared with the same period one year ago.

Asset quality remained solid with both nonperforming assets and net charge-offs declining from the same period one year ago.

Turning to Slide 6, the Company's taxable equivalent net interest income decreased $4 million or 0.5% from the first quarter and increased $29 million or 4% from the year-ago quarter.

Our net interest margin for the second quarter was 3.69%, an 8 basis point decrease from the first quarter and a 2 basis point decline from the same period one year ago.

The competition for both loans and deposits remained strong in our markets and the continuation of the flat yield curve will put pressure on the net interest margin.

Our expectation is for our net interest margin to decline to the mid to low 3.60% range during the second half of the current year.

Turning to Slide 7.

Our average loans grew by 760 million or 1.1% unannualized from the first quarter of 2006.

Compared to the same period one year ago, average loans increased by $3 billion or 4.6%.

These increases were the result of growth in our commercial loan balances.

Average commercial loan balances were up 7.8% in the current quarter versus one year ago and up 1.4% unannualized versus the first quarter.

Our expectation for the second half of 2006 is for our commercial growth to be in the mid single-digit range.

Average consumer loan balances are down from the same period one year ago and relatively unchanged from the prior quarter.

We continue to believe that until we see more of a return to a positive slope in the yield curve, consumer loan demand will remain relatively flat as consumer preference remains toward longer dated fixed-rate maturities versus the variable rate home equity product offering we have historically retained for our portfolio.

Turning to Slide 8.

Our second-quarter average core deposit balances were up 1.3 billion or 2.6% unannualized from the first quarter of 2006 and up 4.8 billion or 10.2% compared to the same period one year ago.

Versus the prior year, DDA balances were up 1.3 billion or 11.2% with growth coming from both personal checking accounts and escrow balances in our commercial mortgage servicing area.

Now, in MMDA balances are also continuing to show good growth with average balances increasing 13.7% compared to the same period one year ago.

Slides 9 through 12 show asset quality trends.

On Slide 9, net charge-offs in the quarter were 34 million or 21 basis points compared with 48 million or 30 basis points in the year-ago period and 23 basis points in the first quarter.

As shown on Slide 10, nonperforming assets at June 30th, 2006 totaled 308 million and represented 46 basis points of total loans and other real estate owned.

This is down 30 million from the year-ago quarter and down 12 million from the first quarter.

Turning to Slide 7, our loan loss reserve at June 30th, 2006 represented 1.42% of total loans.

And on Slide 12, our coverage ratio of our allowance to nonperforming loans stood at 343% at June 30th, 2006.

Looking at Slide 13, the Company's tangible capital to asset ratio was 6.68% at June 30, 2006, which is within our targeted range of 6.25% to 6.75%.

During the quarter, we repurchased 4 million of our common shares and reissued 1.4 million shares under employee benefit and dividend reinvestment plans.

As of June 30th, we had 12.5 million shares remaining under our current board repurchase authorization.

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

Slide 14 provides our third-quarter and full-year 2006 earnings outlook.

Our guidance for the third quarter is for earnings per share to be in the range of $0.70 to $0.74 and for full year 2006 earnings to be in the range of $2.85 to $2.95 per share.

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?

(OPERATOR INSTRUCTIONS).

John McDonald, Banc of America Securities.

Jeff, could you give us a little color in terms of the financial outlook.

EPS ranges for the third quarter and for '06?

What assumptions are in there for charge-offs and then can you give any color on what you're assuming for the provision relative to charge-offs in there?

Yes, John.

I think with respect to the charge-off level, it will be in the 20 to 30 basis point range.

I mean call it the mid 20s type of a range for charge-offs for both the third and the fourth quarter.

If you look at our nonperformers, our nonperformers continue to show improvement in the second quarter so we don't really see anything at this juncture that is lying out there.

Okay, and do you assume in your numbers that you are roughly matching the provision to the charge-offs for the second half?

I think for purposes of doing your projections, that's a good assumption.

Okay.

What have you said historically is kind of a quarterly average for principal investing gains over time for you guys?

Is there a normal range?

Obviously it's lumpy.

It is lumpy, John.

I think if you were to look at a quarter, it could be anywhere from 10 to $20 million.

Okay.

Last thing was just a little more color on commercial real estate.

You guys have mentioned stepping on the brakes a little bit.

Is this a combination of demand slowing and also just a little more caution on your part?

I'll let Chuck Hyle answer that question.

Yes, I think our focus has really been on the cautionary side, particularly in the Florida area and some of the condominium areas, so that's really where our focus has been.

In terms of where you have slowed down, Chuck?

Okay, thanks, guys.

Matthew O'Connor, UBS.

Can you guys give a little more color in terms of why deposit growth was so strong, including on the non interest bearing side?

Well, Matt, year-over-year, the non interest bearing deposits grew because of the ORIX acquisition that we completed in December.

That added about 1.2 billion in non interest-bearing deposits to our totals.

But we also experienced some growth in our personal DDA balances.

Okay, then actually, I was talking about linked quarter, I'm sorry, where it seems like you were priced the interest-bearing deposits a bit more -- maybe that explains some of that growth, but the non-interest-bearing was strong as well, linked quarter.

They were.

Again, we continue to add commercial mortgage servicing and along with all of our commercial mortgage servicing comes additional escrow balances.

It's a little bit different, as you know, from mortgage servicing on the -- or mortgage business on the consumer side.

These balances are much stickier with us and they are there for an extended duration.

Okay.

And then maybe you could provide a little more color on the net interest margin forecast of -- and down 5 to 10 basis points, maybe a little bit lower than we had thought, what's driving that?

Matt, that's really coming from the competitive pressures in the marketplace.

We have chosen to meet those competitive pressures to retain those depositors and as we have been doing, growing those particular relationships with our customers.

Okay, then in terms of the regions where you're seeing more pressure?

I think it's fair to say at this particular juncture that the regions are becoming more equalized so we're seeing competitive pressures throughout the various regions.

However, as we have said in the past, the Midwest still remains the most competitive of the four regions in which we operate.

Brent Erensel, Portales Partners.

Thank you.

I have a question on the expense side.

Given you did have some rather large principal investing gains in the quarter, how much of that 816 million of non-interest expense might you consider discretionary or investment spending?

You did mention marketing and other professional expense.

Yes, marketing expense came up from a relatively low level in the first quarter.

I think if you look at some of the -- I would not call it discretionary, but additional expense that we have been talking about during the course of the year, would be professional fees to meet the compliance demands associated with the consent that we have with the regulators.

And our expectation would be that certain of those professional fees will decrease in the second half of the current year.

A lot of the work has been done in the first part of this year and was done in the fourth quarter and the third quarter of a year ago.

Can you quantify those professional fees?

Well, I think you can see there's a 10 million increase in professional fees year-over-year related to the compliance related efforts that we have, just foe the quarter.

Jeff Davis, FTN Midwest Securities.

Good morning.

Henry, your balance sheet is in great shape -- capital reserves, asset quality, funding continues to get better.

What's your thought on acquisitions as far as on the depository side?

Well as we have said in the past, our first hurdle there is to get back in terms of our compliance efforts to the level that the regulatory agencies are looking at us.

And I expect that to happen in the not too distant future but it's not something that I control.

But that's number one because we are not really in the market to do acquisitions.

While we have been told that we can't get expedited approval, as I read between the lines, we really have got to get our compliance processes and technology and then our compliance throughput up to competent and I'm shooting for a higher than competent level.

And that's going to continue to take us some time in 2006.

But, as you say, as we look at our strategic options, we think we have got a business model in Community Banking that Beth Mooney is running, in our National Banking activities that Tom Bunn is running, that make us an attractive candidate for smaller and regional banks to say they would be a part of.

As we all know, there aren't a lot of deals being done right now because the difference between bid and offered is still pretty wide.

My hope is that through our execution, we get out of our regulatory issues, we continue to perform well and position Key to be there when activity picks up, i.e., when sellers agree to sell at something less than 4 times book.

And Henry, whenever that day may come, will we likely see Key to acquire in the existing footprint, the West, Intermountain West, or jump out of market as Matt said he did with Harbor?

Well we have always said that we will never say never but we are much more focused on extending or complementing our existing franchise.

We think we can pay a more competitive price to the sellers because we can take costs out and as we have admitted in the past, we don't have the market share in all of our 23 districts that we would like to have.

So that is our highest priority but it isn't our only and stick to 100% focus on that.

We are also opportunistic and would look for opportunities at the right price.

And then last follow-up.

Would you ever be interested in an MOE such as, or a quasi MOE such as Beth's old employer, AmSouth Regents?

You know, I can answer that very, very quickly, never say never.

Kevin St. Pierre, Sanford Bernstein.

My questions have been asked.

Thank you.

Tony Davis, Ryan Beck.

Good morning.

I would tell you, Beth, welcome to Key.

I wondered if you could spend just a few seconds on talking about your priorities here over the next several months and where the Company stands in terms of installing the new Argo Teller Systems, where you are in rolling out the DHP scorecard.

Is that still going to be something that you use in Community Banking to track performance, et cetera?

Sure, Tony, I would be glad to.

I have obviously been off the ground a little more than 60 days.

And I have been in the throes of doing as I have been charged by Henry Meyer to verify our strategy of the Community Bank, which I think is very sound and I believe it is the right model to differentiate our performance over time.

We do have a matter of building our client basing staff and executing to our expectation so we will have a lot of work to do and we will do that with as much pace and intensity as we can over time.

The DHP process or differentiating for high performance is a very important tool as we look out to our various managers in our markets as a way to set the appropriate focus and goal setting and then over time measure, reward and recognize that.

So that is going to be an integral part of how we execute that strategy and we are in the process of deploying the Argo Teller 21 system that we call it and that will be done over the next year.

But as we sit here today, we have already deployed the terminals into our KeyCenters and they are being well-received by both our clients and our staff in the KeyCenters so that is a positive for us.

And there's many, many exciting things going on here and lots of hard work and looking forward to doing both.

Thanks.

Tom, perhaps could you give us any color on the backlogs by borrower size and geography that you guys are seeing?

I wonder if the large corporate business is any stronger than middle market small business throughout the footprint and if you could give any color on what you are seeing geographically or regionally?

Well, there are a couple of questions in there.

First off, we are pleased with our pipeline.

We are pleased with both our loan pipelines and our investment banking pipelines.

When you look at the second quarter from an investment banking standpoint, our numbers were up both linked and year-over-year.

Linked 18%, year over year, 37%, which I think demonstrates that the model is working from the standpoint of using capital to generate investment banking revenues.

At the same time, I think the markets are competitive.

We have continued to see strong price competition through both our commercial bank, our leasing business.

Real estate is not quite as price competitive but we have continued to see some price competition there.

As Chuck said earlier, we've looked at several markets and [cap it] breaks there.

On the institutional side, we really play more in the smaller end of the institutional side.

We have seen some margin widening, driven through the institutional leverage business.

I think the institutional investors there are a little more disciplined.

But we do see some relief there but that's the only place we have seen any sort of improvement in pricing and we don't anticipate improvement in pricing through the commercial leasing and real estate businesses through the rest of this year.

David Pringle, Hoefer & Arnett.

Nice quarter in a difficult, really rotten environment.

A couple of questions.

One, the 30 to 89 day past dues were up $100 million.

Sort of wondering if you'd give us a little color -- I want to thank you for putting that in -- a little color on the increase and then what kind of my migration you might expect out of that, please?

This is Chuck Hyle.

Let me take that question.

I think that we've seen a little bit of an uptick in that category in Champion.

We think it's driven largely by the variable rate part of the portfolio.

It's starting to have a little bit of an impact there.

I think we have been managing that for a little while.

And I think we still feel relatively okay given that the LTBs in that portfolio are still very strong, right around 70%.

So we have been able to manage that part of the portfolio pretty well.

So a slug of that is in there.

Similarly, we're seeing a little bit of and uptick in the small ticket leasing and I think probably for the same reasons.

And given residual values and things of that nature, we're still managing that pretty well.

All the other indicators are moving in the right direction, so we are obviously watching it carefully but that's really where the action is.

There was also one credit, I think, that represented a large part of that that's already been resolved (multiple speakers).

There was and it's basically been refinanced by another institution, so that accounts for part of it as well.

Well generally, have you been seeing migration out on 30 to 89 day and sort of 90 past (multiple speakers)?

Not so much on Champion, no, we haven't, nor on the leasing side.

So again, we're watching it carefully but thus far, there's some noise in there, but I think we're managing it quite well.

And then your construction portfolio was up again, and correct me if I am mistaken.

Housing is slowing a lot.

At some point, would we expect to see the growth rate in that slow or possibly go negative?

Yes, I think that's quite possible that that will happen.

We are seeing some strength in certain pockets of real estate, but some slowing in some others and so again, we have got a very large and very diverse portfolio and that helps us quite a lot.

What percent of that portfolio is single-family mortgage related or single-family?

I'm not sure I have that percentage right in front of me.

We would have to go back to the 10-Q on that.

It hasn't changed dramatically.

I don't think we have the percentage right off the top of our heads right now, David.

And then given the commitments and stuff, what do you think the growth would start to slow?

This is Jeff Weeden.

We provided, David, overall guidance for the commercial portfolio.

That would include the commercial real estate; that includes commercial and industrial.

It includes leasing.

We have provided our guidance there to be in the mid single digits for the balance of this year.

David, let me give you just an indication too.

This is Tom Bunn.

For the first quarter of '06, linked quarter growth was 3.6 in our total real estate book, commercial real estate book.

And for the second quarter, linked quarter growth dropped to 2%, which is by far our slowest growth probably in eight quarters, which as we anticipate it and we have actually been speaking about that for the last probably three quarters as we have looked hard at some of the hot markets and tried to, as Chuck said, tap the brakes.

So we are not at all surprised by the decline in growth quarter over quarter from last year's fourth to first to second.

So, I think this is going as we planned it would.

Well, sure, I mean I would just expect the construction, given a long history of Key of incredibly good commercial real estate asset quality that you guys would be careful with construction portfolio, I guess.

Yes, and David, the residential properties represents about 15.5% of the portfolio.

Of the construction portfolio?

Yes, 15.5.

So basically 15.5% of your total construction portfolio was single-family (multiple speakers)?

That's of the total portfolio.

Total commercial real estate is 15.5.

Okay.

You guys sound like you are avoiding drilling down into the construction portfolio but that's all right.

No, I don't believe so.

I don't --

(OPERATOR INSTRUCTIONS).

Mike Mayo, Prudential.

I came on a couple minutes late.

I just want to be clear, you're raising guidance for the year but the only big change is that now the margin assumption is going to be what like 5 to 10 basis points lower?

So what's the explanation?

I think if you look, Mike, back at what we have performed for the first two quarters, we are at $1.45.

So we have had better performance in the first two quarters of this year than what was initially forecast and that is really driving the difference.

Okay, so it's really just the headline numbers to these quarters?

That's correct.

I think our quarterly guidance -- this is the first time we have given third-quarter guidance.

And so $0.70 to $0.74 is for the third quarter and the $2.85 to $2.95, which is simply -- that's what our expectation is at this particular point.

And investment banking did really well.

Would you say it was up 18% linked quarter?

How do the backlogs now compare to what they were at the start of last quarter?

Tom, you can talk about that.

Mike, we are pleased.

I think a lot of that is going to be driven, as you can imagine, by the condition of the capital markets.

Obviously, the equity markets have struggled, which I am sure has resulted in all firms having some deals postponed.

And so as we look forward, we're optimistic that the pipeline and the model works.

But as we all know, we are susceptible to market conditions.

So the backlogs are down a little bit right now?

I don't think I said that.

I guess you're being vague because it's still uncertain out there?

Correct.

But we feel good that the model is working and that our first quarter and first half has been indicative of what we can do.

I am just trying to figure out -- are more deals getting pulled at the more midsize companies that you deal with than at the larger firms or is it the same amount?

Are there different factors at work there?

I don't think they are different factors.

I think we're all suffering from the same challenges in the market.

Okay.

And then -- thank you, Tom.

And service charges on deposits, they seem to be going up at a few different banks that reported this morning.

How much leverage do you have there?

Mike, this is Jeff Weeden.

I think what we typically have is a seasonal change in deposit service charges.

So the first quarter is generally the low part of the year for us.

We have had some improvement year-over-year.

Again, there are multiple factors that are involved there.

Obviously, as interest rates continue to increase, corporate depositors are able to offset their analyze deposit service charges with their balances.

So that hurts from a hard dollar charge but we have seen increased activity across the consumer side of the bank and have experienced growth there.

And then lastly, letters of credit fees were up pretty nicely.

What's happening there?

Well, I think it's just a normal business activity.

I think we were a little bit low at one juncture.

I haven't -- I'd have to go back and look at letter of credit fees but it strictly is going to be based upon the amount of credits and commitments that we are extending.

Okay.

Actually, one last thing.

One thing that sticks in my head is, Henry, you said never say never when it comes to a merger of equals.

And going back to society and KeyCorp way back when, you kind of started off the cycle.

What do you think is going to happen with regard to consolidation?

Well, I think consolidation will continue.

Mike, I think there's too many banks, you know, just the competition that we all talk about here in the Midwest.

We find pricing much more competitive in the Midwest, a little bit closer now across all of our four regions.

But we've commented in the past about how it's more competitive here, largely because this is a more fragmented market than some of the other markets that we operate in.

So I think continued consolidation will happen.

I hope that we are in the right position to take advantage of that.

On the other hand, to my never say never, if there was any merger of equals type of deal that created value for our shareholders, made the resulting company a stronger company, those are all things that we consider in the interest of doing the right things for our shareholders.

Chris Chouinard, Morgan Stanley.

I had a quick question or two quick questions.

The first one is on loans held for sale.

Within that, the components, it looks like the level of commercial real estate and commercial mortgage -- I'm sorry, commercial mortgage and C&I increased a little bit.

Is that sort of the tapping on the brakes that you're talking about in terms of maybe looking to sell down some exposures?

I think we have just strengthened the (multiple speakers)

(indiscernible) demonstrated some growth in our syndications backlog and in our floating-rate trading book.

So these are tied to -- these would be larger credits that you're just looking to sell down?

Two things.

Transactions which we are leading, we are -- have underwritten and are selling; and then like other situations, it is a trading book where we run an active floating-rate trading book to support our syndications capability.

Understood.

And secondly, switching gears on credit, I was wondering if you could give some color on NPL inflows this quarter and in prior quarters just to give a sense for how that is trending, as well as anything you can share about the watchlist?

I think on the press release on Page 19, we actually have a summary of changes in nonperforming loans.

So if you look at that particular summary on that back schedule, you'll see that the flow of loans placed on nonaccrual are fairly comparable to what happened in the first quarter and it's down from the fourth quarter of last year.

So that will give you the flow and the payments, etc., that have happened on that particular portfolio.

Anything you can share about sort of the watchlist?

We typically haven't disclose a lot of watchlist information.

So it's not something we have put in our 10-Q.

It appears we have no further questions at this time.

Mr. Meyer, I would like to turn the call back over to you for any additional or closing remarks.

Thank you, operator.

I just want to thank everyone for participating with us on the call this morning.

It was a relatively clean quarter for a company our size and we're proud of the results.

And the guidance that we gave, you know, we're comfortable that the balance sheet, the P&L, the direction of the Company is in good shape right now.

So with that, we will sign off and again thank you for your participation.

Once again, that does conclude today's call.

We appreciate your participation.

You may now disconnect.