KeyCorp (KEY) 2007 Q4 法說會逐字稿

Good morning, everyone, and welcome to KeyCorp's fourth quarter 2007 earnings results conference call.

This call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to the Chairman and Chief Executive Officer of KeyCorp, Mr.

Henry Meyer.

Mr.

Meyer, please go ahead, sir.

Thank you, operator.

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

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

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

Slide two is our forward-looking disclosure statement.

It covers both our presentation and the Q&A portion that will follow.

Before I discuss the strategic actions, shown on slide three, I think it's important to point out that Key has been positioning itself for a potential downturn in the credit markets.

Specific actions include: curtailment of our Florida condominium exposure, the sale of our subprime home mortgage lending business more than a year ago, and our recent decision to exit dealer-originated home improvement lending and cease conducting business with nonrelationship home builders outside of our footprint.

Also, and importantly, we have no meaningful CLO, CDO, asset back commercial paper or SIV exposure.

Slide three highlights the strategic actions that were previously announced on December 20th to bolster Key's loan loss reserve and manage our expense structure as we enter 2008.

These actions include: increasing our loan loss reserves with a provision that exceeded net charge-offs by $244 million, and adding $25 million to the provision for unfunded commitments.

The additional loan loss provision reflects deteriorating market conditions and the residential property segment of Key's commercial real estate construction portfolio.

We also transferred approximately $1.1 billion of home builder-related loans and $800 million of condominium exposure to our special Asset Management group.

And as we said in our earnings release today, the majority of these credits are currently performing and expected to continue to perform.

We announced our decision to exit several nonscale or out of footprint operations specifically our nonrelationship home builder lending outside of our 13 states community bank footprint, the payroll online services, which were not of sufficient size to compete profitably, and the dealer originated home improvement lending, which involves prime loans, but is conducted largely out of footprint through Key's National Banking group.

We will continue to offer home equity loans to customers within our community banking footprint.

And, we initiated a proactive expense revenue in the fourth quarter of 2007, aimed at sustaining Key's competitive position.

As a result of this review Key has or will eliminate 570 existing positions and 300 open positions.

An additional 170 positions will be eliminated in 2008 as a result of our decision to exit the businesses I just mentioned.

We have also continued to focus on building our core relationship banking business.

On January 1st, we completed the acquisition of USB Holding Company, Inc., the holding company for Union State Bank, headquartered in Orangeburg, New York.

This acquisition doubles our branch penetration in the attractive Lower Hudson Valley area.

And finally, our Board of Directors declared the 2008 first quarter quarterly cash dividend of $0.375 per common share.

This represents a 2.7% increase over the prior quarterly dividend.

On slide four, you can see our strong dividend track record.

This board action marks the 43rd consecutive year of dividend increases which places us among a very select group of companies in the S&P 500.

S&P recognizes these companies with a designation dividend aristocrat.

This decision is also o strong signal from our board about their confidence in the underlying strength of our company.

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

Jeff?

Thank you, Henry.

I'll begin with the financial summary shown on slide five.

My comments today will be with respect to Key's results from continuing operations for the fourth quarter of 2007.

In some cases I'll comment on comparisons to both the fourth quarter of 2006 and the third quarter of 2007.

Our earnings per share for the fourth quarter of 2007 were impacted by the actions we announced on December 20, to add to our reserve for loan losses and exit certain business activities, as well as the market-related charges we incurred in our held for sale portfolios.

In addition, the visa accrual sweeping through the banking industry in the fourth quarter adversely impacted our results.

For the fourth quarter of 2007, we earned $0.06 per share from continuing operations, compared to $0.76 per share for the same period one year ago, and $0.57 in the third quarter of 2007.

I'll comment further on our fourth quarter results in our 2008 outlook as we review the remaining slides in our presentation.

Turning to slide six, the company's taxable equivalent net interest income for the fourth quarter of 2007 increased $38 million from the third quarter, and $6 million from the same period one year ago.

For the fourth quarter of 2007, our net interest margin increased eight basis points to 3.48%, from the third quarter level and was down 18 basis points from the same period one year ago.

Our margin benefited in the fourth quarter of 2007 from a lease accounting adjustment which increased taxable equivalent net interest income by $18 million and added approximately nine basis points the net interest margin.

The company experienced a similar adjustment in the fourth quarter of 2006.

Excluding the fourth quarter 2007 impact from the lease accounting adjustment, our margin would have declined by approximately one basis point from the third quarter of 2007.

Our performance here was a little better than what we were expecting, as we moved to reprice deposits with a general decline in short-term market rates during the fourth quarter.

As we have talked about in the past several quarters, the competition for deposits remains strong in our markets and we believe will continue to pressure the margin into 2008.

We would also note that credit spreads have widened for new lending arrangements in the upper end of the middle market and in the large corporate lending segments.

However, this same trend has not worked its way through other lending segments in which the competition for loans remains high.

Given the continued strong competition in our markets and the elevated levels of nonperforming assets, we believe the margin will remain under some pressure in 2008.

Our current expectation for the net interest margin in 2008 is for it to be in the 3.30% range.

Slide seven highlights the changes in noninterest income between the fourth quarter of 2007, and the third quarter of 2007, and the fourth quarter of 2006.

As we stated in our earnings release, and in our earlier comments, the fixed income markets continue to have an adverse impact on our fourth quarter noninterest income.

However, when compared to the third quarter of 2007, our results were significantly better.

For the fourth quarter, our noninterest income was up $50 million from the third quarter and down $70 million from the same period one year ago.

During the fourth quarter, we experienced good growth in our trusted investment services fee income, compared to the third quarter.

Prior year comparisons are impacted by the first quarter 2007 divestiture of McDonald investments.

Excluding the McDonald results from the fourth quarter of 2006, year-over-year trust and investment service fee income increased by $21 million or 19%, driven by both personal and Institutional Asset Management businesses.

We also experienced good growth in our deposit service charges compared to both the prior quarter and the same period one year ago.

Net losses from loan securitization and sales decreased in the fourth quarter, compared to the third quarter, due to smaller marks on our held for sale portfolios and a $28 million -- $28 million in gains realized from the sale of commercial leased financing receivables during the fourth quarter.

Compared to the prior year, income from this line item was down $48 million.

The current year negative marks on the held for sale portfolios compared to gains in the prior year from the securitization of student loans and commercial mortgages, makes comparisons difficult.

Due to market conditions, we did not proceed with the securitization of our student loans in the fourth quarter of 2007.

At this point in time, we do not know when market conditions may improve to the point where we may wish to complete a securitization.

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

Several items impacted our overall noninterest expense during the fourth quarter.

In the nonpersonnel area, we recorded -- in the personnel area, we recorded severance expense of $24 million, compared to $4 million in the third quarter.

We also increased our provision for non -- unfunded commitments to $25 million from $5 million in the third quarter, and we recorded a $64 million charge representing the estimated fair value of Key's liability to Visa, Inc.

in the fourth quarter.

Comparisons to the fourth quarter of 2006 are impacted by these same items, plus the vestiture of the McDonald Investment Branch Network.

Turning to slide nine, average loans from continuing operations increased $2 billion or 11.9% annualized from the third quarter of 2007, and were up $4.1 billion or 6.3% compared to the fourth quarter of 2006.

Average commercial loan balances were up 7.5% in the fourth quarter versus one year ago, and up 15.3% annualized from the third quarter of 2007.

Average consumer loans were up 3.1% from the same period one year ago, and were up 2.7% annualized from the third quarter level.

We experienced strong linked quarter growth in our CNI portfolio in our national banking lines of business coming from real estate capital and the institutional banking areas.

This growth was partially due to the disruptions we saw in the fixed income markets during the second half of 2007.

Customers who may have financed their transactions in the capital markets in the past looked to us and other banks to help them with their funding needs.

For 2008, as a result of our continued deemphasis on our home builder and condo exposure, we expect to see commercial loan growth in the low-single digit area for the year.

Our outlook consumer loan growth is also in the low-single digit area, given our belief that consumers will be guarded with respect to taking on additional debt until they get a better feel for the direction of the U.S.

economy, and the value of their homes.

In addition, our decision to exit the dealer-originated home improvement lending area will also impact our growth.

These growth expectations do not include the balances which we acquired as part of the Union State Bank acquisition on January 1st, 2008, which were approximately $900 million of commercial loans and $600 million in consumer loans as of the acquisition date.

Turning to slide 10, I'll speak briefly to the changes we experienced in our average core deposits in the fourth quarter versus the third quarter.

Comparisons to the first quarter in prior periods shown are impacted by the McDonald Investment Branch Network.

The dotted line on this chart represents the year-over-year percentage growth comparisons, excluding the impact of the McDonald deposits sold.

Our core deposit balances were impacted in the fourth quarter by continued intense competitive pricing pressure.

While we have talked in the past about the regional differences in pricing across the company, with the western half of the country being more rational, we did not see this in the fourth quarter.

Pricing for deposits has become just as competitive in the west as it is in the eastern half of the United States.

We believe that with the disruption in the capital markets and the ability to raise wholesale funds on the part of banks in general, many competitors chose to maintain or increase their deposits, even given the fed -- even while the fed was cutting rates.

We chose to remain competitive with our pricing, and at the same time we reduced rates in many areas in response to the cuts and the targeted fed funds rate.

Within our community bank, we saw average deposit growth of $0.5 billion or 4.5% annualized for the fourth quarter, compared to the third quarter of 2007, with most of this growth coming in CDs greater than $100,000.

Core deposits were relatively flat with the third quarter.

Versus the fourth quarter of 2006, average total deposits from the community bank, adjusted for the $1.6 billion of deposits sold with the McDonald Investment Branch Network, increased $1.5 billion or 3.4%.

On the national banking side, average deposit balances for the fourth quarter were flat with the third quarter.

In our real estate capital line of business, deposits were down approximately $0.3 billion as interim loan servicing and the related escrow balances declined in the fourth quarter.

This was a result of fewer commercial mortgage loan balances being structured into CMBS products during the fourth quarter.

In addition, we reclassified approximately $3.4 billion of DDA balances to the MMDA category during the fourth quarter.

This had an impact on our reported average as well as ending balances for both the DDA and the now MMDA categories.

As of the end of the fourth quarter, our commercial mortgage services portfolio stood at $135 billion and had $3.9 billion of escrow deposit balances associated with this business.

Our expectation for 2008 is to see core deposits grow in the low-single digit range.

Slide 11 shows our asset quality summary.

Consistent with our announcement on December 20th, net charge-offs in the quarter were $119 million or 67 basis points, compared to $59 million or 35 basis points in the third quarter, and $54 million or 33 basis points for the same quarter one year ago.

While not shown on this slide, our provision for loan losses was $363 million in the current quarter, and exceeded net charge-offs by $244 million.

Nonperforming assets at December 31, 2007, totaled $764 million and represented 1.08% of total loans, other real estate owned and other nonperforming assets.

This compares to $570 million or 83 basis points at the end of the third quarter, and $273 million or 41 basis points one year ago.

As we stated in today's earnings release, and in our December 20, 2007, announcement, the increase in nonperforming assets and the additional provision expense were primarily results of deteriorating market conditions in our commercial real estate construction portfolio.

As part of the actions taken during the fourth quarter, we are also moving to exit approximately $1.1 billion of home builder and $.8 billion of condominium exposure located outside of our 13-state community banking footprint.

The majority of the $1.

million -- $1.9 million -- billion -- $1.9 billion in loans identified are in projects located in Florida and California.

Outside of the commercial real estate construction portfolio, we experienced a modest increase in our consumer nonperforming loans during the current quarter.

The reserve for loan losses at December 31, 2007, stood at 1.69% of total loans, and our coverage ratio of our allowance to nonperforming loans stood at 175%.

Our current outlook for net charge-offs for 2008 is in the 60 to 70 basis point range.

Looking at slide 12, the company's tangible capital to tangible asset ratio was 6.46%, and our tier one capital ratio was 7.37% at December 31, 2007.

Our targeted ranges for the tangible and the tier one ratios are 6.25% to 6.75%, and 7.50% to 8.0% respectively.

During the fourth quarter, we did not repurchase any of our common shares and reissue activity was limited at just 85,000 shares under employee benefit plans.

At December 31, 2007, we had 14 million shares remaining under our current board repurchase authorization.

We currently do not anticipate any share repurchase activity in the first quarter of 2008, as we rebuild our tier one capital ratio to our targeted range.

Slide 13 is a summary of our current outlook for selected line items for calendar year 2008.

As Henry mentioned in his comments, we closed the Union State Bank acquisition on January 1st, 2008.

This added approximately $1.5 billion of loans and $1.8 billion of deposits to the company as of that date.

Also, we anticipate that with the actions taken in the fourth quarter to exit certain portfolios in the home builder area and the home improvement area, loan growth will be slower in 2008 than experienced in 2007.

In addition, we are expecting held for sale loan balances to be lower in 2008 compared to 2007.

Overall, we anticipate average earning asset growth in the low-to-mid single-digit range in 2008, compared to 2007.

We expect the margins to remain under some pressure due to the items previously discussed and to be in the 3.30% range for the year.

With respect to credit costs, we currently expect net charge-offs in the 60 to 70 basis point range for the year and provision will depend on specific facts and circumstances surrounding nonperforming assets and the migration of credit up or down.

With the actions taken in the fourth quarter to address our costs, excluding the Visa related charges and the reserve for unfunded commitments provisions taken in the fourth quarter of 2008 -- or 2007, expense growth in 2008 will be well-controlled and in the low-single digit range.

We also expect our effective tax rate to return to the 32% to 33% range in 2008.

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

Operator.

Thank you.

Our question-and-answer session will be conducted electronically.

(OPERATOR INSTRUCTIONS) We'll take as many questions as time permits, and we'll proceed in the order that you signal us.

As a reminder ,there may be many callers holding to ask a question at one time, so we appreciate your patience.

Our first question of the morning will go to Terry McEvoy at Oppenheimer & Company.

Please go ahead.

Good morning.

Could you be a little more specific on the expenses recorded in Q4 associated with the expense review that's going on?

And then looking out into 2008, within your guidance this morning, does that include additional call it one-time expenses as part of this review, or do you think there will be above and beyond your guidance today?

Well, Terry, in the fourth quarter, as far as the separation charges, there were $24 million worth of severance or also some professional fees associated with the outplacement and other activities.

That was primary in there.

There's also -- we recorded a $5 million charge associated with the writing off of goodwill with the payroll online business.

And that's in the other expense.

As you recall from the -- I think it's identified clearly in the press release, the $64 million for visa, the provision for unfunded commitments, which for the year was around $28 million, those particular items we would not anticipate at those levels obviously in 2008.

And the guidance that we provided of low-single digits excludes a number of those charges related to Visa and the unfunded commitments.

I think as you look at the separation charges, there was also a reduction of incentive compensation accruals, both in the third and the fourth quarter of 2007.

And those would probably be offset increases in 2008 against the separation charges that we incurred in 2007.

Okay.

And then just one other question.

Could you talk about deposit relationships that KeyCorp has with some of your home builder clients, particularly those that are -- they're out of footprint and those loans that were transferred to the special Asset Management group, and then also the quality of those deposits as well?

Terry, this is Tom Bunn.

One of the reasons we are exiting a number of those relationships is that they weren't really relationships.

They were more opportunities in those regions, nonfranchise, and because they weren't in our franchise footprint, we did not have significant deposit relationships.

So you will not see a significant impact on our deposit relationships because of those being moved to the exit portfolios.

Appreciate it.

Thank you.

Our next question goes to Tony Davis at Stifel Nicolaus.

Please go ahead.

Good morning.

Just a few more details here.

Tom, keep going here.

I wonder what you could tell me about what you're seeing right now in loan syndication and CMBS syndication volumes, and then kind of what your expectations are I guess for the rest of the year.

Tony, starting with syndications, we were pleased with the volume we had in the fourth quarter coming out of the institutional side of the bank, both institutional real estate as well as institutional corporate.

Clearly some of that is driven by M&A-related activity which has slowed.

That said, we did see some M&A activity in the fourth quarter, slide to the first quarter, which will close, which will provide financing opportunities.

But quite honestly, our outlook for the capital market side of the business is really going to be driven by how open those capital markets are.

As Jeff said, we do not anticipate significant growth year-over-year in those businesses until we have a better view of those markets.

Second question was CMBS.

Right.

The CMBS pipeline has fallen off dramatically.

The fourth quarter was about -- estimated about 20% of normalized volume.

We expect no better than 40% to 50% of normalized volume this year.

As Jeff mentioned, our interim financing has shown a significant slowing, and again, we don't see that really improving until we get some calming in the markets and a better indication of rates in the take-out side.

Are you -- what are you seeing, Tom, on mortgage services pricing, and what's the likelihood that you'll be adding some this year, you think?

This may not be -- we continue to see strong competition in the mortgage services pricing.

We will continue to look to add there, but we will not be stupid about paying for it.

And finally, Beth, a question for you.

I just wondered how many of the branches you're looking to upgrade this year, and what we can expect there in terms of incremental expense impact?

Yes, Tony.

We have a -- currently have about 65 branches in flight for our branch modernization and updating, and then we'll be looking to do another 100 to 150 this year in our modernization program.

And we have accounted that -- for that in our expectations for our 2000 expense -- 2007 -- 2008 noninterest expense.

But given most of that is capital, it will not have a significant impact.

Got you.

Thank you.

We'll go next to John Boland at Maple Capital Management.

Please go ahead.

Hi, thank you.

Yes.

I'm just trying to get more clarity on the reserve side and your methodology.

The consensus is that the next couple of quarters are certainly going to be a lot worse than what we've seen, and your allowances seem to be going up at a much slower pace than your nonperforming assets or your charge-offs, and just looking for any kind of clarification.

This is Chuck Hyle.

I think our main focus clearly has been on the commercial real estate side.

And we took a very detailed look in December at our commercial real estate business.

And as we have indicated, both looking at exit names, as well as parts of the residential portfolio -- residential construction portfolio, that have underperformed in the last six months.

And we've tried to take quite a conservative view of that portfolio, looking out into the future.

And that's where the special reserves come from.

And while not -- the majority of our exit names are still performing and we do expect them to continue to perform, there's clearly weakness in certain parts, particularly in California and in Florida.

And our perspective on that was to increase our reserves to look through the next 12 months, to be as adequately reserved for that part of the portfolio as we possibly could.

The rest of the portfolio has continued to perform well.

Our commercial and institutional businesses have continued to perform well and in line with expectation.

Our consumer portfolios we started to see some modest migration starting four months ago through the fourth quarter.

We have seen some continued migration, but it has been relatively modest.

And we continue to view that part of the portfolio, as well as our middle market portfolio, to essentially perform in line with the economy.

And that's our perspective.

Okay.

And can you provide any granularity on the -- maybe the geographic trends you might be seeing, you just mentioned California, but within the core markets are you seeing any particular -- or do you have any breakdowns, who is really getting hit a little harder than others?

Are you speaking about real estate or broadly?

Real estate.

Primarily real estate.

Yes, primarily -- California and Florida are our two weakest areas.

Most of the rest of the geographies have performed relatively well.

We're seeing a little weakness in Nevada, but we're not particularly exposed there.

We've seen some weakness in Michigan, but we are very underexposed in Michigan in real estate.

Pacific northwest continues to perform well, most of the northeast does.

So it's really -- most of our focus on the negative side is just certain parts of California and certain parts of Florida.

Which are really noncore markets, correct?

Correct.

Yes.

And just one last bit of information, if you could, and I'll hang up.

But would you say you're being very proactive in the modeling?

It almost sounds like you're letting the economy drive the reserves.

And I'm just wondering if you could shed any light on that.

Well, as I say, I think our -- we will perform in line with the economy.

But as we look at the economy and our view of the economy changes, as that has an impact on the model.

And our models are very sensitized to economic activity.

And we are certainly seeing some migration we would attribute to a weakening economic environment, and those do show up in the models that we have.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS) And we'll go next to David Pringle, I believe it is at [Felspoint] Research.

Please go ahead, sir.

Good morning.

Good morning.

Jeff, your guidance on the margin is -- does that take into account the fed cut today?

Well, it was based on the blue chip forecast.

Obviously, I haven't had an opportunity to go back and remodel the margin with the most recent activity that happened this morning.

But directionally, we were modeling for decreasing rates over the next 12 months.

So there's a degree of guidance -- the guidance has a degree of decline in general interest rates over the next 12 months.

But did it have the magnitude of the move --

I don't know if anybody did, David, to be quite honest.

If you were to look at people's analysis, the way we're positioned, we perform better with a decrease in rates.

Depends on how low the fed ends up ultimately going with rates, obviously.

And looking at competitive factors that are out there in the marketplace, how fast competitors respond also to this change in the overall rate environment.

Yes.

Thank you.

And Mr.

Meyer, we have no other questions at this time, so I'd like to turn the call back to you for any closing comments, sir.

Thank you, operator.

Again, we thank all of you for taking the time from your schedule to participate in our call today.

If you have any follow-up questions on the items we discussed, please don't hesitate to call Vern Patterson in our Investor Relation's department.

I'm sure all of you have Vern's number, but I've got it too.

It's 216-689-0520.

That concludes our remarks, and we wish everyone to have a good day.

Thank you.

That does conclude the call.

We do appreciate your participation.

At this time you may disconnect.

Thank you.