KeyCorp (KEY) 2007 Q1 法說會逐字稿

Good morning, and welcome to the KeyCorp's first quarter 2007 results conference call.

This call is being recorded.

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

Henry Meyer.

Mr.

Meyer, please go ahead, sir.

Thank you, operator.

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

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

Joining me for today's presentation is our CFO, Jeff Weeden, and also joining me for the Q&A portion of the call are vice-chairs,Tom Bunn and Beth Mooney, and Chuck Hyle, our Chief Risk Officer.

Slide 2 is our forward-looking disclosure statement.

It covers both our presentation and the Q&A session that follows.

Now if you'd turn to slide 3.

Key's results in the first quarter of 2007 were affected by strategic actions taken to improve our business mix and to reposition the balance sheet.

During the quarter we completed the previously-announced sales of the McDonald Investments branch network and the Champion Mortgage origination platform.

Both transactions are consistent with our strategy of focusing on Key's core relationship businesses and exiting those areas where we don't have either the scale or an opportunity to build profitable relationships with our customers.

In the first quarter of 2007 we also repositioned our securities portfolio in response to changing market conditions.

We expect this change to enhance the Company's future performance, particularly in the event of a decline in interest rates.

And finally, we were very pleased to favorably resolve the auto lease residual value insurance litigation that has been pending since 2001.

As a result of this settlement, Key recorded an after-tax gain of $17 million or $0.04 per share in the first quarter.

Before I turn the call over to Jeff, let me comment on one other item.

We have continued to strengthen our compliance practices related to anti-money laundering and the Bank Secrecy Act.

We added new monitoring technology, enhanced employee training, and increased support staff.

I feel confident that we are taking the right steps to satisfy the conditions of our regulatory agreements.

Having said that, however, the timing for lifting those agreements will be determined by the regulators and will be based on our continued progress.

Now I'll turn the call over to Jeff Weeden for a review of our financial results.

Jeff?

Thank you, Henry.

I will begin with a financial summary shown on slide 4.

Income from continuing operations was $0.89 per share in the first quarter of 2007.

This compares to $0.76 per share in the fourth quarter of 2006 and $0.66 per share for the same period one year ago.

We have applied discontinued operations accounting to Champion Mortgage for all periods presented in our press release and conference call slides.

The sale of McDonald Investments branch operation did not qualify for discontinued accounting treatment.

Our first quarter results were impacted by the gain we recognized on the sale of McDonald Investment branch operations, as well as the other items Henry mentioned.

Turning to slide 5, we have summarized the McDonald Investment branch sale gain, the litigation settlement and securities portfolio repositioning activities our first quarter results.

Accounting for these items, we come down to an adjusted earnings on $0.68 per share for the first quarter of 2007.

Turning to slide 6, the Company's taxable equivalent net interest income for the first quarter decreased $44 million from the fourth quarter and decreased $22 million from the same period one year ago.

As we stated in our fourth quarter earnings call, our results for the fourth quarter benefited from two items that added approximately $24 million to taxable equivalent net interest income and benefited the margin by approximately 12 basis points.

For the first quarter of 2007 our margin was 3.50%, down approximately four basis points from the adjusted fourth quarter level and down 22 basis points from the same period one year ago.

We have continued to experience narrower spreads, particularly on deposits, as the inverted yield curve continued to persist throughout the entire first quarter.

Our repositioning of the securities portfolio last month should benefit net interest income and the net interest margin in coming quarters, and provide us some extension in the duration of our assets.

While competition for both loans and deposits has remained strong in our markets, lending spreads have remained relatively stable over the past several quarters.

Given competitive factors, the current interest rate environment and the actions we have taken to reposition the securities portfolio, we would expect the net interest margin to remain relatively stable, around the 3.50% range in 2007.

As of the end of the first quarter, our exposure to a 200-basis point change in short-term interest rates over the next 12 months remains relatively neutral.

Slide 7 highlights the changes in noninterest income between the first quarter of 2007 and the fourth and the first quarters of 2006.

First quarter of 2007 results were impacted by the three items noted earlier; the gain on the sale of McDonald Investments branch operations, the litigation settlement and the repositioning of the securities portfolio.

Trust and investment services income is down due to the McDonald branch divesture.

In the current quarter we recorded approximately $16 million in fees from the McDonald operations compared to $32 million in the fourth quarter and $36 million in the first quarter of last year.

Investment banking and capital markets income is down from one year ago due to the $25 million gain we recognized from the initial public offering of the New York Stock Exchange last year.

Investment banking fees were relatively unchanged from the same period one year ago and down $22 million from the seasonally high fourth quarter levels.

Our pipeline for investment banking opportunities remained good at the end of the first quarter.

Turning to slide 8, we have prepared a similar comparison of the increase/decrease in noninterest expense between the first quarter of 2007 and the fourth and the first quarters of 2006.

Personnel expense compared to the same period one year ago is up due to higher stock-based compensation expense, salary adjustments and staff additions.

Compared to the fourth quarter personnel expense is down due to lower incentive compensation accruals.

Turning to slide 9, our average loans from continuing operations increased $96 million or 0.1% unannualized from the fourth quarter of 2006 and were up $1.4 billion or 2.3% compared to the same period one year ago.

Average commercial loan balances were up 3.4% in the current quarter versus one year ago and up 0.6% unannualized from the fourth quarter of 2006.

Average commerc -- consumer loan balances were down 0.9% from the same period one year ago and down 1.1% unannualized from the fourth quarter level.

We have continued to maintain our focus on prime lending HELOC segment of the Community Bank over the past several years.

Due to the variable nature of this product and the slope of the yield curve consumer preference has been towards longer-dated fixed-rate product which has not been the focus for our portfolio.

As we look to the remainder of 2007, our expectation is for commercial loan growth in the low to mid-single digit range and for the consumer balances to remain relatively stable.

Turning to slide 10 our first quarter average core deposit balances were down $1.8 billion or 3.4% unannualized from the fourth quarter of 2006 and up $115 million or 0.2% compared to the same period one year ago.

The sale of the McDonald Investment branch operations impacted the average core depal -- deposit balance comparisons.

For the first quarter of 2007 we had $0.7 billion of average core deposit balances associated with McDonald compared to $1.6 billion in the fourth quarter and $1.2 billion in the first quarter of 2006.

These balances were primarily in our NOW and MMDA balances.

The sale accounts for approximately one-half of the decline between the first quarter of 2007 and the fourth quarter of last year.

Versus the prior year, DDA balances were up $0.5 billion or 4.3%, with growth coming from both personal checking accounts and escrow balances in our commercial mortgage servicing area.

NOW and MMDA average balances decreased $1 billion or 4.2% compared to the same period one year ago.

Our CD balances were up $0.8 billion or 6.9% from the same period one year ago, as consumers continued to shift money out of MMDA balances and into CDs.

Adjusting for the impact of the McDonald sale, we expect core deposit growth in the low to mid-single digit range in 2007.

Slides 11 through 14 show our asset quality trends.

On slide 11 net charge-offs in the quarter were $44 million or 27 basis points compared with $54 million or 33 basis points in the fourth quarter and 24 basis points for the same period one year ago.

While credit quality should remain relatively good compared to historic averages, we believe we will see an increase in charge-offs over the balance of 2007.

Our expectation for the remainder of 2007 is for net charge-offs to be in the 30 to 40-basis point range.

As shown on slide 12, nonperforming assets at March 31, 2007, totaled $353 million and represented 54 basis points of total loans, other real estate owned and other nonperforming assets.

This compares with $273 million or 41 basis points in the fourth quarter and $320 million or 48 basis points one year ago.

The increase in nonperforming commercial loans in the first quarter of 2007 primarily relates to our equipment finance line of business.

The majority of the increase in other nonperforming assets in the first quarter is attributable to one investment of approximately $51 million by the private equity group within our real estate capital line of business.

Turning to slides 13, our loan loss reserve at March 31, 2007, represented 1.44% of total loans, and on slide 14 our coverage ratio of our allowance to nonperforming loans stood at 372% at March 31, 2007.

Looking at slide 15, the Company's tangible capital to tangible asset ratio was 6.97% at March 31, 2007, which remains slightly above our targeted range for this ratio of 6.25% to 6.75%.

During the first quarter we repurchased eight million of our common shares and reissued 3.3 million shares under employee benefit plans.

At March 31, 2007, we had 22 million shares remaining under our current board repurchase authorization.

We anticipate the continued use of share repurchases in the overall management of our capital levels.

And finally, slide 16 provides our updated 2007 financial outlook.

Using the adjusted earnings of $0.68 for the first quarter, our updated 2007 guidance for earnings is in the range of $2.80 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] We'll take our first question from Brent Erensel at Portales Partners.

Hey there, thank you.

And I'm just wondering, the new guidance that you have, $2,80 to $2.95, compared with the old guidance of $3.00 to $3.10, how much that is related to the flat yield curve and the slowing economy as distinct from the disposition of McDonald and Champion?

It's primarily related to the interest rate environment that we're operating in and continue to operate in.

As you can -- our prior guidance that we provided excluded the impact of McDonald from the previous range.

Can you quantity that?

I think in terms of -- if you see the range of $2.80 to $2.95 we basically were $3 to $3.10 before, so our guidance has been we were in the mid-$3.50 range prior to this on our net interest margin.

We brought that down to around $3.50.

We had a little slightly higher loan growth for the duration of 2007 in our prior guidance, so overall earning assets have come down a little bit in our guidance and the margins come down slightly in our guidance, so looking at it I would say it's primarily related to net interest income is the decline.

Thank you.

We'll take our next question from Ed Najarian at Merrill Lynch.

Good morning.

Morning.

I guess my question is a bit similar to Brent's.

The interest rate environment has not changed tremendously over the last three months since you issued your previous guidance.

Additionally, you have not really been impacted by the subprime issues that have arisen over the past three months.

So I guess I'm looking for more insight on why your outlook has changed significantly against a back drop which admittedly is difficult but doesn't seem like it has grown tremendously more difficult since January?

Well, I'd say, Ed, it hasn't really gotten better either since January.

As we continue to see tight spreads overall and consumer preferences I think continue to shift towards CDs in the current rate environment, as consumers are locking in to what they perceive to be higher rates, that particular shift has had a continued impact on us.

Obviously we're going to continue to look at other ways to generate loans and deposits, but we've taken that into account in our updated guidance that we've provided.

We saw a little bit slower growth than what we were anticipating in the first quarter, and until we see a shift in those growth patterns, we've taken that into account in our updated guidance.

I think if you look at some of the market-sensitive revenue, first quarter is always a soft quarter for us, and while we expect that future quarters will be better in those particular areas, until those revenues are actually booked, we don't count them.

Is there anything going on on the credit side that's changing your outlook?

We did see a pretty big increase in nonperforming assets in the first quarter relative to the fourth.

And in conjunction with that, would you say there's anything going on with respect to your commercial real estate business that's changing your guidance?

I will first comment on the credit, and then I will ask both Chuck Hyle and Tom Bunn to talk about the other businesses.

I think with respect to overall credit our guidance before was mid-to upper-30 basis point range.

We've actually widened the guidance out and brought the lower end down.

So credit quality in the first quarter, while nonperforming assets were up, charge-offs were down from the fourth quarter level and actually were quite good, so --

This is Chuck Hyle.

I would add to Jeff's comments that we've seen a bit of negative migration in the portfolio, nothing terribly dramatic and nothing that we would necessarily say would change our outlook for ultimate charge-offs.

Okay, thank you.

And with respect to the commercial real estate business from either a credit or volume standpoint?

Tom, why don't you talk about volume?

Ed, this is Tom Bunn.

If you look at the volume, we have talked about for the last 18 months that we had proactively slowed the exposure in certain areas, specifically the condo business, and I think we've talked about in the last few earnings calls about how our home builder business has -- growth has slowed quarter over quarter.

We've also seen slowing in the other single family related areas, and I think for the first quarter in probably two years our actual real estate balances were down.

Now, we do not expect that to continue because we believe that the proverbial rat has gone through the snake in the condo exposure situation, and we're going to replace that exposure with -- and we're seeing it with strength in the commercial office building, retail, and multi-family, so we feel good about Jeff's numbers for the rest of the year.

We think the real estate portfolio will grow low to mid-single digits for the rest of the year, and we feel good about the credit quality in that, but I will turn it over to Chuck and let him talk about the credit quality.

Yes, I think, again, we're seeing a little bit of negative migration in the home builder sector in the residential side but good strength on office and other categories.

Again, we feel pretty confident about the general quality and our ability to manage that portfolio, so while we may see a few bumps along the road in terms of NPL's or NPAs, our overall outlook for the sector is still pretty solid, so we don't see it going into charge-offs in any material way.

Okay.

The other thing I would add to that, Ed, is that we are also seeing pretty stable margins in the real estate business as well.

Since we have exited the more -- the wider spread condo lending business -- exited I will say, because we haven't exited, we've reduced our exposure in that business -- it's good to see that margin stabilize.

Okay.

Thank you.

That's all helpful.

We'll take our next question from Terry McEvoy at Oppenheimer.

Morning.

Morning.

Could you just talk about the size and overall characteristics of your real estate related investments within the private equity unit?

And just out of curiosity if there was a credit loss incurred in that business, would it come out of principle investing within the income statement or would it be a typical charge off?

Terry, this is Chuck Hyle.

Let me take a stab at that.

We had a -- really quite a small mezzanine private equity portfolio in our real estate business.

It's quite well spread amongst commercial and residential, and it's quite well spread from a geographic perspective.

The one blip that you see in the numbers this quarter in the NPA side is one mezzanine investment, which is one of our larger ones, where it's essentially a condo conversion.

The absorption rates, as we all know, are a bit slower in this particular project.

The senior debt we bought out because we feel that there is good value in this investment.

The senior bank involved in a smaller regional bank with a lot of exposure in that sector, really wanted to get out, so we thought there was value.

And as a consequence our investment in that portfolio is $51 million, which is obviously a lot larger than the rest of our investments in that portfolio, but we see value.

It's going to take a little bit of time because of the absorption rates, but we think it's still quite a decent asset, and we're going to work it out.

Bit the rest of the portfolio is relatively small, as I said, well spread across a range of things, I would say the average investment is well below $5 million in each investment, and that's an important issue, and that's how I would summarize that portfolio.

With respect to losses on it, it would not hit the charge-off book, it would go through the real estate capital line of business and impact other income.

Last quick question.

Was there a gain or loss at all associated with the sale of the Champion platform?

If you look at the discontinued operations results, there was a -- it included not only the sale of the platform but obviously real estate severance and other activities, so it shows up as a $0.02 loss from discontinued operations in the current quarter.

Appreciate it.

Thank you.

We'll take our next question from [Phillip Ducwisch] at Elmridge Capital Management.

Good morning.

Just a couple of clarifications.

Is it correct to think that the run rate of fees going forward is going to be -- everything else being equal is going to be lower by $19 million, considering that that's what I estimate McDonald contributed in the first quarter?

And in similarly that the personnel expense and the non-personnel expenses will be reduced by $15 million and $19 million, again due to McDonald?

Is that the right way of looking at it?

The way we would look at it -- that's why we provided the adjusted numbers over there -- is to look at that adjusted column.

Those were the numbers for the first quarter.

Now bear in mind that the first quarter is usually our softest quarter with respect to overall fee revenue, and we typically have a seasonal as we go throughout the entire year.

The other aspect on the expense side of the equation would be that, as market-sensitive revenues or fee revenues increase, there's also a corresponding increase in the form of incentives that are paid against those particular market-sensitive revenues.

Okay, thank you.

And then the second question is that -- I'm not sure I understood your comments on -- to Brent earlier about the old guidance of $3.00 to $3.10 and the current guidance.

Did the old guidance, that was excluding anything from McDonald, the litigation, and obviously you didn't have the securities portfolio loss in there as well.

Is that correct?

That is correct.

Okay.

And the $2.80 to $2.95 has the subsequent gain that you had from McDonald, the gain on the residual and the loss on the securities, is that right?

No, it excludes all of that.

Oh, it -- okay.

So the $2.80 to $2.95 excludes what -- it's just taking the $0.68 of operating earnings from the first quarter?

That's right.

The actual guidance has assuming $0.68 -- adjusting the $0.68 for the first quarter, guidance for the year would be $2.80 to $2.95 per share.

Okay.

Thank you very much.

Appreciate it.

Certainly.

[OPERATOR INSTRUCTIONS] We will take our next question from [John Bowlin] at Maple Capital Management.

I was wondering if you could shed any light on what might be going on on the expense side, especially anything forward-looking on perhaps cost control or expense cutting?

Well, we certainly continue to look at all of our expenses throughout the organization, and as we've gone through the divestures of both McDonald as well as Champion, we continue to look at our shared support costs and try to control those as much as we can and bring down reductions in those particular areas.

Costs are certainly a focus of the organization, but also the long-term goal of the Company to grow our top-line revenue and to make the investments that we need to continue to make in the Community Bank as we go through and modernize our branches and put in new technology there.

So it is a matter of getting better improved efficiency by the ruling out of technology, as well as watching all of our support costs within the organization.

It's part of our culture.

We've really built in, I think, in the prior years.

Henry Meyer and the rest of the team going back five, six, seven years ago, instituted a culture around here to focus on the cost side of the equation.

And would -- I guess following up on that then, would -- have you given any consideration about perhaps cutting down the number of community bank markets you're in or somehow consolidating the number you're in?

Let me take that.

We're always -- and we talked about this in previous calls, but we use economic profit added as a measure for our existing businesses, for new investments, and we're continuing to look at, as just a normal process, what the contribution of businesses and geographies are.

If the correlation here is the revenues are slower, you're looking to divest of something, that doesn't necessarily work that way.

Both Tom Bunn from the national banking perspective and Beth Mooney from the Community Banking perspective.

as well as the staff areas that report to me.

we're very conscious of one of KeyCorp's priorities.

which is positive operating leverage.

And when revenues don't come through, management has to look at expenses all across the board, but it doesn't focus -- it doesn't necessarily push us to focus on one district or another.

That's more strategic, and we continue to look at that on a regular basis.

I hope that's helpful.

It is.

Thank you.

It appears we have no further questions at this time.

I'd like to turn the conference back over to Mr.

Meyer for any additional or closing remarks.

Thank you, operator.

Once again, I'd just like to thank everyone for taking time to be with us today, and if you have any questions that come up further later, please don't hesitate to give Vern or his team a call.

Thank you.

Thank you.

That does conclude today's conference.

You may disconnect at this time.