KeyCorp (KEY) 2006 Q3 法說會逐字稿

Good morning and welcome to KeyCorp third quarter 2006 earnings results conference call.

Today's call is being recorded.

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

Thank you, operator.

Good morning and welcome to KeyCorp's conference call.

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

Joining me is our CFO.

Jeff Weeden, and also joining me are Vice Chairs Tom Boston and Jeff Beth Mooney.

Slide 2 is the forward-looking statements is covers the presentation and the Q&A period this follows.

If you turn to slide 3.

Overall, it was another good quarter for Key.

Our improved performance was driven been by solid asset quality trends.

Compared with the third quarter of last year, tax equivalent revenue was up $37 million due to solid commercial loan growth and increase in core deposit and higher fee income.

Asset quality also remained solid.

Non-performing assets decreased by $64 million from the third quarter of 2005.

Net charge-offs were down $6 million and represented 25 basis points of Key's average total loans for the current quarter.

The next point on slide 3 deals with regulatory compliance.

I am very pleased with our continued progress on improving our systems and processes related to anti-money laundering and other compliance controls.

Over the past year we've 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 we made is attributable to the significant effort of our entire organization and especially those in our compliance area who have taken a leadership role in making sure that we meet or exceed the new regulatory requirements.

As I have said in the past, the timing of the lifting of the consent order is not solely up to us.

We will continue to work with the regulators to ensure we meet all of the new regulatory requirements for a sustainable process here at Key.

We have also continued to improve our business mix, which is highlighted on the next slide, slide 4.

During the past five years, we've made a number of changes to improve our business mix in order to build a more relationship-focused company.

In September we announced that Key had agreed to sell its McDonald's rEtail Brokerage Business.

This continues to move to the scale players who can invest in the technology and management resources required to be successful.

We remain on track to close this sale in the first quarter of 2007.

As we stated in our press release announcing the sale of the McDonald brokerage business, we will remain McDonald's profitable institutional business that has been doing business for the past few years as KeyBanc Capital Markets.

In August, we announced that we were exploring the sale of Champion Mortgage, our non-prime retail mortgage lender.

Champion has been a profitable business for us but operates primarily outside of our 13-state footprint and provides limited opportunities to build a relationship with these customers.

On the left-hand side of this slide you can see that we have made acquisitions in our bank-based franchise as well as our national businesses such as commercial real estate, equipment leasing and asset management.

With those brief comments I will now turn the call over to Jeff 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 $0.76 per share in the third quarter compared to $0.75 per share in the second quarter, and $0.67 per share in the same period one year ago.

Our taxable equivalent revenue was up $37 million or 2.9% from the year ago period.

Net interest income increased $25 million and fee income was up $12 million.

Included in total fee income was a loss of $7 million from the sale of securities compared to a net gain of $3 million in the year ago period.

Earning asset growth of 4.6% was driven by an increase in commercial loans.

Average total loans were up 1.9% from the year ago period.

During the third quarter, we moved $2.5 billion of loans to a held for sale category in conjunction with our announcement to explore the sale of Champion Mortgage.

Excluding the Champion portfolio, consumer loans declined by 1% from the year ago period and were down slightly from the second quarter.

Total commercial loans increased 7.5% in the third quarter, compared to the same period one year ago driven by strong C&I and commercial real estate construction lending.

Average core deposits grew by 8.1%, compared to the same period one year ago.

Asset quality remained solid with both non-performing assets and net charge-offs declining from the year ago period.

Turning to slide 6, the Company's taxably equivalent net interest in decreased $1 million from the second quarter and increased $25 million or 3.4% from the year ago quarter.

Our net interest margin for the third quarter was 3.63%, a 6-basis point decrease from the second quarter and a 4 basis point decline from the same period one year ago.

Competition for both loans and deposits remained strong in our markets, and the continuation of the flat yield curve continues to put pressure on the net interest margin.

While spreads on most of our new business volumes are not getting any tighter, they are not yet expanding.

Our expectation is for our net interest margin to remain under some pressure during the fourth quarter, potentially declining by a similar number of basis points as we experienced in the third quarter.

Turning to slide 7, our average loans declined by $1.4 billion or 2.1% unannualized from the second quarter of 2006.

This was a result of moving the Champion portfolio to a held for sale category during the third quarter.

Excluding this reclassification, average total loans were up 0.3% from the second quarter and up 4.5% compared to the same period one year ago.

Average commercial loan balances were up 7.5% in the current quarter versus one year ago and up 0.4% unannualized versus the second quarter.

As we look to the fourth quarter, we expect our commercial loan growth will be in the low to mid-single digit range annualized and that our consumer loan balances will remain relatively stable.

Turning to slide 8, our third quarter average core deposit balances were up $133 million or 0.3% unannualized from the second quarter of 2006, and up $3.9 billion or 8.1% compared to the same period one year ago.

Versus the prior year, DDA balances were up 870 million, or 7.1% with growth coming from both personal checking accounts and escrow balances in our commercial mortgage servicing area.

NOW and MMDA average balances decreased -- or increased $2.3 billion or 10.2% compared to the same period one year ago.

NOW and MMDA balances were down $117 million or 0.5% unannualized from the second quarter as we saw consumers shift money from transaction accounts into CDs.

Our CD balances grew 244 million or 2.1% unannualized from the second quarter, and were up $895 million or 8.3% from the same period one year ago.

Slides 9 through 12 show our asset quality trends.

On slide 9 net charge-offs for the quarter were $43 million, or 25 basis points compared with $49 million or 30 basis points in the year ago period, and 21 basis points in the second quarter.

Our expectation is for our net charge-offs to remain in the 20 to 30-basis point range during the fourth quarter.

As shown on slide 10, non-performing assets at September 30, 2006, totaled $329 million and represented 50 basis points of total loans, other real estate owned and other non-performing assets.

This is down 64 million from the year ago period and up 21 million from the second quarter.

Turning to slide 11, our loan loss reserve at September 30, 2006, represented 1.44% of total loans.

On slide 12, our coverage ratio of our allowance to non-performing loans stood at 423% at September 30, 2006.

Looking at slide 13, the Company's tangible capital to tangible asset ratio was 6.81% at September 30, 2006, which is slightly above our targeted range of 6.25 to 6.75%.

During the quarter, we repurchased 2.5 million of our common shares offsetting the number of shares reissued under employee benefit and dividend reinvestment plans.

As of September 30, we had approximately 10 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.

Finally, slide 14 provides our fourth quarter earnings outlook.

Our guidance for the fourth quarter is for earnings per share to be in the range of $0.72 to $0.76.

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

Operator?

[OPERATOR INSTRUCTIONS].

We'll start with Gary Townsend with Friedman Billings Ramsey.

Good morning, gentlemen, how are you?

Good morning.

Can you discuss your provisioning methodology and particularly just noting that the provision was less than charge offs?

Yes, Gary, this is Jeff Weeden.

Our provision for the current quarter, the reason for being below our net charge-offs happened to be that we moved the 2.5 billion of the Champion portfolio to a held for sale category.

The reserves associated with that were released, and so that's what you saw coming back through.

Okay.

When you look at your performing portfolio and looking at migration of performing assets but not in substandard or in a classification, what are you seeing these days?

Chuck, do you want to address that question on the trends with respect to classified and criticized assets?

The things are looking pretty stable at this juncture.

We're seeing maybe just a small amount of migration in within or two spots, commercial real estate, but otherwise things are pretty much as they have been for the last couple of quarters.

Thank you.

We'll go next to Mike Mayo with Prudential.

Good morning.

Good morning, Mike.

Can you comment what's happening with deposit pricing?

I am getting mixed signals from what I am hearing.

Some are saying it's gotten better the last few weeks.

Some are saying it is still tough.

Maybe elaborate on that in the context of expectations for lower margin in the fourth quarter.

Well, Beth Mooney will comment on the deposit pricing.

Good morning, Mike, as it relates to deposit pricing, as you know, at this point in the curve, we've seen basically total deposit pricing rise across many markets.

We have held our deposit rates relatively stable going from the second into the third quarter.

Competitively we see the tightest rates obviously in the Midwest and the Northeast and still a more stable and lower cost environment in the West.

So we have held stable.

We don't anticipate at this point the cycle necessarily increasing any of our account rates.

We intend to remain competitive, but we do not see any reason to increase from where we are, and then we have seen a consumer preference shift to go to CD's as Jeff noted in his commentary and have seen increases in that book as consumers have a preference to lock up slightly higher rate for a term.

Any letup in the last three or four weeks?

I have not seen any particular letup in the last three or four weeks, but I would say it is a more stable environment than it was perhaps 60 days ago.

And then with that as a backdrop, why do you still expect the margin to go down?

What are some of the factors there?

Mike, this is Jeff Weeden.

I think the reason for the margin, some of the guidance we're providing on the margin for potential decline in the fourth quarter relates to, again, as Beth was talking about, the shifting of the deposits from some of the transaction accounts over into some of the time CD balances.

And just generally, do you see that as cyclical or secular, what's happening with the transaction accounts?

I think as we get to the -- there is an optical level, certain competitive environment where consumers can find a 5% rate on a CD.

They're moving into that particular category and locking it in and taking it out of transaction deposits.

I think we're just at that point of the rate cycle.

It is an optical thing for people to lock into that rate.

Last question, any update on your ability to pursue acquisitions?

Henry will address that.

Mike, as I allude to do in my comments, we're not in charge of that timing, and we continue to work with both the Fed and the OCC in terms of the progress that we made, but it is in their court.

Thank you.

We'll go next to Brent Erensel with Portales Partners.

Any dilution associated with the sale of the mortgage company coming up?

Have you plans to replace the earnings you lose from that and then second, with some clarification on the increase in non-performing assets in the quarter, do you see that as an ongoing trend now up $20 million per quarter?

First I will address the question related to the potential divestiture of Champion.

We'll quantify what that particular impact will be when the transaction ends up happening.

We will continue to look obviously for opportunities for reinvestment of that capital, but at this particular point in time the dilution associated with that transaction would not be a material amount for us.

Chuck Hyle will address the non-performing.

On the NPL side numbers this quarter, linked quarter, are down about $6 million if you move ought the champion from NPL to NPA.

The increase in the NPA over and above the Champion shift really relates to one real estate deal that was an equity investment.

We actually bought out the debt, and we expect the valuation of that asset to actually be completely immaterial on our earnings and maybe even a small gain.

Thank you.

We don't see that as a particular trend.

Thanks.

We'll go next to Tony Davis with Ryan Beck.

Good morning, gentlemen and Beth.

Wanted to know if you can provide some color on C&I, the backlog, what you're seeing about borrower size, and geography, maybe in Tom's area, KCIB versus middle market versus small business.

I will start on that.

I think on the C&I side we have seen real estate continue to grow but grow at a slightly slower pace and in different spaces.

The homebuilder side has grown but over the last three quarters the rate of growth has declined and we expect that to continue because we've seen commitments become stable over the last three quarters.

We've replaced that growth with growth in the commercial side of real estate more in the retail and commercial construction and real estate side.

Also we've seen consistent growth in the leasing business over the last three quarters which in the 2 to 3% range quarter over quarter offset some of the more transactional volatility that we see in the institutional side, so overall we're pleased with as Jeff said, we pleased with the sort of sing I will digit growth on an annualized basis we expect beef had and expect to see going forward.

On the commercial side overall that's been a little bit slower growth.

We've seen growth in the Northwest, pretty consistently over the past couple of quarters.

Not surprisingly, we've seen softness in the Midwest over the past couple of quarters.

The Northeast has been flat or down a little bit, and we've had good growth in the agri-business side.

I think it is regional, and I don't think you can have a general statement about the -- about where it is going to go going forward.

Overall we're very comfortable with what Jeff outlined on the overall commercial growth to low to mid-single digits over the next quarter.

Tom, how about capital markets backlog in your area?

Actually the capital markets backlog, we've had a good year in the investment banking side from M&A to equities to fixed income to syndication.

The pipeline is strong.

As you know, a lot of those are related to how the markets do in the fourth quarter and how your particular sectors do in the fourth quarter.

We are optimistic about our pipeline going into the fourth quarter.

Thank you much.

We'll go next to Terry McEvoy with Oppenheimer.

Good morning.

Did the $28 million net gain from principle investing, was there any expenses that possibly offset some of that gain in the third quarter?

The only expense item that we've specifically identified would be the contribution to Key Foundation of $10 million in the third quarter.

That would be the specific one.

We saw a nice decline in our professional fees, which we were anticipating happening in the second half of the year, so that's come down approximately $10 million, and then our marketing efforts also have come up in the second half of the year, so we've had a shift between what we were spending on professional fees and been able to redeploy that and really build up some of the marketing efforts.

And just the next question, have all the costs experienced with meeting the regulatory requirements, have they been recorded in each respective quarter since this came about last year, or will some of them be recorded when it is all behind you?

It is -- it is an as-incurred basis.

Clearly what we see systems costs that have been put in place and capitalized obviously for all the new AML/VSA tracking software and systems that are in place will be depreciated in the ordinary course of business on a go-forward basis.

All professional fees and additional personnel that we've hired throughout the entire company for compliance efforts are incurred and reported in the current periods.

Thank you.

We'll go next to Gerard Cassidy with RIBC Capital Markets.

Good morning.

Can you share with us how the sale of Champion Mortgage is going, and is the agreement with the regulators affecting the sale at all?

Gerard, it's Henry, I will take that one.

The answer is because it is not a banking activity, and it is a divesture, the regulators are not an issue in this particular alternative.

We continue to explore different alternatives as it relates to the sale of Champion, and we haven't made any final decisions there, but, there is always a big risk putting time frames on things.

This isn't a fire sale.

It is a strategic sale.

It doesn't fit the relationship side of the business, and we're trying to optimized to our shareholders what getting out of this business might mean.

Okay.

Back to the deposit comments about the customers, your customers moving more to CDs, have you been able to quantify at all the impact that the internet might be having on the rates of deposits, particularly the direct dotcoms that have been popping up such as Citibanks or HSBCs?

Are you seeing more competition from the internet today than a year ago?

Is it going to be a factor of possibly keeping interest rates elevated for a longer period of time than in prior rate cycles when the internet wasn't around?

Gerard, I will attempt to answer that that question.

I would say overall the internet is certainly a channel that's out there.

It provides consumers with a great deal of information, but in our strategy of really being a relationship-based bank, we get most of our business is going to come through our branch network and through our own internet site obviously and our telephone centers, so while it has an impact, I would say it is an immaterial impact on our overall strategy.

Gerard, this is Henry.

You will probably remember that we were one of the leaders in terms of both using the internet and using a separate channel.

We called it KBUSA, KeyBanc USA, and we would advertise higher rates there.

To Jeff's point, there is a channel and there is a customer base, but there is not a lot of overlap.

When you deal as we do in a relationship, the vast, vast, vast majority of those relationship-oriented clients of Key and of other financial institutions are not shopping in that channel, and so we actually folded KeyBanc USA into KeyBanc because we didn't see growth in that channel consistent with our relationship strategy.

Okay.

Some credit quality questions.

Could you share with us -- it looks like you sold off about $22 million of non-performing loans versus $6 million in the prior quarter.

How is that secondary market for problem credits, is it pretty robust in terms of demand for those types of credits?

The short answer is yes.

The market is very wide and pretty deep, and there are a lot of players out there, and we expect to see that liquidity continuing.

And what type of pricing were you able to receive on off the original par value of those loans?

In most cases we've done quite well, but it is -- we are attempting I think quite successfully to get to these assets earlier rather than waiting and as a consequence the pricing has held up quite well.

Some banks indicated they get par- are you getting 100 cents on the dollar on the sale these loans.

Occasionally.

Occasionally there is a slight premium.

You also show us that the in-flows of problem loans were about $134 million which is above the second quarter and the first quarter levels, and right above that, you give us the 30 to 89-day past due numbers which are steadily rising.

Would this suggest that fourth quarter non-performing assets if the trends continue would rise as well?

It is always hard to predict.

We've seen bubbles in the 30 to 89-day delinquency area before.

We tend to get at them pretty quickly, and for the most part they tend not to translate into 90-plus, and if you look at our 90-plus numbers they're only up modestly, about $6 million dollars, and we're doing everything we can to maintain that trend line.

Great.

Last question, Jeff, could you come back to your answer on the provision versus charge-offs?

It seemed like you were going to add something and you were cut off if you could share with us why the provision was less than the charge-offs in the quarter?

Yes.

The provision was less than that charge-offs because of the simple fact that we moved the portfolio Champion portfolio out of the loan portfolio and down into a held-for-sale category, and the reserves associated with that were released during the current quarter.

We go through a very elaborate process to build up the reserve here based upon each individual credits or classifications of credits throughout the entire portfolios, so it is a pretty extensive process that is in place, and, it happened to be that this particular quarter because of the fact that we moved that portfolio the reserves did in fact come down slightly.

Thank you.

Any losses going forward would be captured in the mark to market in the held for sale category as opposed to us being able to go back to the loan-loss reserve which is why the release happened.

On the Champion portfolio, correct.

Thank you.

We'll go next to Matthew O'Connor with UBS.

Good morning.

You guys have done a nice job the last couple of years in reducing the consumer credit risk.

Anything left to do such as the RV relending or anything else?

Well, I think we continue to look at all of our portfolios and look for where we can get the best overall returns for the Company, but there are no decisions that have been made on any of those remaining portfolios.

We are in those businesses.

We are trying to grow those particular businesses and make a solid rate of return for our shareholders.

Okay.

And then just separately, looking past the regulatory constraints, what type of acquisitions in the bank space would you be most interested in geographically and size and are there any swap opportunities that always seems like would make a lot of sense for you if it could ever get done?

We've touched on a couple of these in the past.

I continue and now Beth more than in the past, but we continue to be looking for fill-in opportunities where our market share in our districts in the 13 states that we're in is not at 10% or in the top 1, 2, 3 or 4, so fill-in's continue to be our highest priority, which doesn't say that we won't look at other opportunities, but that's really what we're focused on.

Okay.

In terms of size last couple of deals you've done have been relatively modest.

Would you be comfortable doing something a bit larger?

Again, and I think we've all heard that banks are not bought, they're sold.

We want to be in a position post regulatory issues to look at the small fill-in community banks as well as regional banks if those opportunities avail themselves, so, we really because of our capital and because of the position we put our balance sheet and economic trends, what we think we're well positioned as time goes on here.

Okay.

Thank you.

Let me address swaps because you asked the question, and it is the same answer.

I would love to look at swaps.

We have looked with other companies at the potential of doing a swap, and while asset swaps make sense a billion from the left going to the right and a billion from the right going to the left, what always happens is that the tax implications of how those assets were acquired, what the basis is, all of those issues tend to make what would look like a very logical swap and an uneconomic opportunity for one side or the other.

That's why they haven't happened in the industry and why we haven't been able to make that work either.

Okay.

Thank you.

Next to David Pringle with Fells Point.

Good morning.

Thank you for taking my call.

Good morning.

Two questions.

First is another question on credit.

Your home equity portfolio stopped growing late last year.

One would think the portfolio would start to age a little bit.

Are you seeing any of that?

In our home equity portfolio it is primarily made up of lines of credit, the HELOC product.

If you look specifically our loan to value which we have disclosed in all of our information and regulatory filings, you will see relatively modest loan to value.

You will see a high percentage of those are first-lien mortgages or first lien positions that we have, so the credit quality has remained very good.

Those are high quality customers.

Those are relationship based for us in the bank, and we are not experiencing anything of the material nature there.

Great.

The second was I think, Jeff, during your comments you talked about the pricing being very competitive on asset and liability side, and is that primarily coming from any one source?

Is it little banks, is it big banks?

Is it big capital markets?

Is it broker?

Talk a little bit about that.

It is very broad based.

It is varied across the country.

Obviously you will have strong local competitors.

You will have regional.

You will have the large banks, but it is very broad based in all of our markets.

And where would you say it is sort of the most brutal geographically?

We've talked about the most competitive market of course is the Midwest market, and then the Northeast and then it is more rational as you get further to west.

Thank you very much.

[OPERATOR INSTRUCTIONS] We do have a follow-up from Brent Erensel with Portales Partners.

I was looking at miscellaneous income which is up fairly sharply, and I was wondering if you could address what that involved and how sustainable that number is at $121 million.

Yes.

I think the category that is really up is the miscellaneous item that's in that total category there.

Principal obviously gains from principal investing we had a very solid quarter this quarter as well as last quarter.

There is some volatility that can go in that particular number, and I don't think we'll experience that same level as we get into the fourth quarter.

As far as what a normal level would be for principal investing, it is hard to give you a specific there.

On the miscellaneous item down below which has the 62 million which is part of the 121 million, that particular number subpoena this quarter.

There are a number of items that are in there.

That number will vary from 40 to $60 million in any given quarter.

I think range in that range is probably reasonable and probably something around 50 would be more in what I would view as sustainable.

I am sorry, of the 121, 62 tash.

You will see that 62 is in miscellaneous.

Miscellaneous/miscellaneous, and that's a difficult one to identify specific for you.

You're saying that number will be between 40 and 60 going forward.

That is correct.

The rest of the miscellaneous/miscellaneous will be in the same range?

I am trying to figure out 120 the new run rate or should we be looking back at 90 to 100 million going forward?

Within that 120 you have $28 million of gains from principal investing, so I think if you look at some of the non-interest income items that we have on page 16 of our press release.

Which is what I am looking at.

In the 120 you have $18 million of insurance income.

That's a pretty stable number.

Yep.

You've got the loan securitizations servicing fees.

That's a pretty stable number at 5 million.

Credit card fees were up this particular point in time.

We had several initiatives that happened.

That was up 4 or 5 million during the current quarter.

Principal investing gains of 28 million, I think that's a high level of -- high water mark for us.

Could we be above that at some time, yes.

Will we be below it, yes.

I think a number in the $15 million range is probably a more reasonable number to use for that particular one, and then the other number you see, the $62 million, I think that number in the 50 million is probably a good average because it will vary between 40 and 60.

Great.

That's very helpful.

Thank you.

Next to Jon Balkind with Fox-Pitt.

I am all set.

Thanks.

You guys answered my question.

It appears we have no further questions at this time.

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

Thank you, operator, and again I want to thank all of you for taking time out of your busy schedules.

I know there is a lot of calls today.

We appreciate the opportunity to get a chance to talk about what again I think was a good quarter for Key.

Thank you, all, and we're signing off.

Once again that does conclude today's call.

We appreciate your participation, and you may now disconnect.