KeyCorp (KEY) 2016 Q1 法說會逐字稿

Good morning and welcome to KeyCorp's first-quarter 2016 earnings call.

(Operator Instructions)

As a reminder today's call is being recorded.

At this time I would like to turn the conference over to Beth Mooney, Chairman and CEO.

Please go ahead ma'am.

Thank you, operator.

Good morning and welcome to KeyCorp's first-quarter 2016 earnings conference call.

Joining me for today's presentation is Don Kimble, our Chief Financial Officer and available for our Q&A portion of the call is Bill Hartmann, our Chief Risk Officer.

Slide 2 is our statement on forward-looking disclosures and non-GAAP financial measures.

It covers our presentation materials and comments as well as the question-and-answer segment of our call.

I'm now turning to slide 3. Our first quarter results reflect momentum in our core businesses and continued progress on our strategic initiatives despite a more challenging operating environment.

Excluding merger related expense, we generated positive operating leverage relative to the year-ago quarter and grew pre-provision net revenue by 6%.

We also lowered our cash efficiency ratio for the first quarter to 64%.

Revenue was up 3% from last year, driven by a 6% growth in net interest income.

Average loans were up 5% from the year-ago period with a 12% increase in commercial, financial, and agricultural loans.

In our non-interest income, we saw year-over-year improvement in areas such as corporate services, and cards and payments, reflecting investments that we have made in these businesses.

Market sensitive businesses such as investment banking and debt placement fees, were impacted by the weak capital markets environment.

Don will provide more detail and our outlook for our fee-based businesses in his comments.

Credit quality measures this quarter were impacted by migration in our oil and gas portfolio reflecting current market conditions.

The rest of the loan portfolio continued to perform well and within our expectations with overall net charge-offs remaining below our targeted range.

We maintained our strong capital position and subject to Board approval, we expect an increase in our quarterly common stock dividend to $0.085 per share in May of this year.

Slide 4 is an update on our First Niagara acquisition.

We were very pleased that the shareholders of both companies approved the merger last month.

This was an important step in the process and we appreciate the support of our shareholders.

We also announced our community benefits plan, which is a comprehensive blueprint for the community investments that we will be making over the next five years.

This underscores our commitment to the areas we serve across our footprint.

I have commented before about the cultural fit between Key and First Niagara and that continues to be evident in the way our two teams are working together.

We have made significant progress in developing detailed business plans and our target environment, including talent assessment and selection.

As we move forward, I'm even more confident in achieving our cost savings and revenue synergies and ultimately delivering on our commitment for value creation for our shareholders.

We continue to expect the acquisition to be accretive to earnings in 2017 and add 5% to EPS upon the full realization of cost savings.

We also expect to increase our return on tangible common equity by 200 basis points, improve our cash efficiency ratio by 300 basis points and produce a solid return on invested capital.

We look forward to completing the next stages of the approval process and continue to expect the acquisition to close in the third quarter of this year.

Now I will turn the call over to Don to discuss the details of our first quarter results.

Don.

Thanks and I'm on slide 6. First quarter net income from continuing operations was $0.24 per common share after adjusting for $24 million or $0.02 per common share of expense related to the acquisition of First Niagara.

This compared to $0.26 in the year-ago period and $0.27 in the fourth quarter.

As Beth mentioned, this quarter's results were negatively impacted by the migration in our oil and gas portfolio.

The rest of our loan portfolio continued to perform well.

Also worth noting is that despite weak market conditions our revenue was up 3% from the prior year.

After excluding merger related expense, pre-provision net revenue was up 6% and we generated positive operating leverage compared to the first quarter of last year.

I will cover the other line items in the rest of my presentation so now I'm turning to slide 7.

Average loan balances were up $2.6 billion or 5% compared to the year-ago quarter and up $580 million from the fourth quarter.

Our year-over-year growth was once again driven primarily by commercial, financial and agricultural loans and was broad based across Key's business lending segments.

Average CF&A loans were up $3.3 billion or 12% compared to the prior year and were up $706 million or 2% on annualized compared to the fourth quarter.

Continuing on to slide 8. On the liability side of the balance sheet, average deposits excluding deposits in foreign office totaled $71.6 billion for the first quarter of 2016, an increase of $2.8 billion compared to the year ago quarter.

The year-over-year increase reflects growth in our commercial mortgage servicing business, inflows from commercial and consumer clients and growth in time deposits.

Compared to the fourth quarter of 2015 average deposits excluding deposits in foreign office increased by $131 million.

Growth in time deposits was largely offset by a decline in the seasonal and short-term deposit inflows from commercial clients that we experienced during the fourth quarter.

Turning to slide 9, taxable equivalent net interest income was $612 million for the first quarter 2016 and the net interest margin was 2.89%.

These results compare to the taxable equivalent net interest income of $577 million and a net interest margin of 2.91% for the first quarter of 2015.

The 6% increase in net interest income reflects higher earning asset balances and yields.

The net interest margin remained relatively stable benefiting from higher earning asset yields, which were offset by higher levels of liquidity and various other items including lower loan fees.

Compared to the fourth quarter of 2015, net interest income was relatively stable and the net interest margin increased by 2 basis points.

The increase in the net interest margin was attributed to the higher earning asset balances and an increase in earning asset yields, which was largely the result of loan portfolio repricing to the higher short-term rates that resulted from the December rate rise.

The benefit of these items was partially offset by various other items including lower loan fees and lower yield on our fed stocks.

Slide 10 shows a summary of non-interest income, which accounted for 41% of total revenue.

Non-interest income in the first quarter was $431 million, down $6 million or 1% from the prior year, and $54 million or 11% from the prior quarter.

The slight decrease from the prior year was attributed to the lower net gains from principal investing of $29 million which were offset by continued growth in several of our core fee-based businesses reflecting our relationship strategy and the investments we have been making in our products and capabilities.

Relative to the year-ago period corporate services income was up 16%.

Cards and payments was up 10%, and service charges on deposit accounts increased by 7%.

Compared to the last quarter, non-interest income was most notably impacted by weaker capital markets activity, which resulted in $56 million and lower investment banking and debt placement fees.

Turning to slide 11, as you can see on the slide and as I mentioned earlier reported non-interest expense of $703 million includes $24 million of expense related to our acquisition of First Niagara.

Excluding these costs non-interest expense was $679 million for the quarter.

We've provided a detailed breakout of our merger related expense in the appendix of the materials.

Compared to the first quarter of last year and after adjusting for merger related expense, non-interest expense was up $10 million or 1%.

The increase was primarily attributed to slight increases across various non-personnel areas.

Excluding merger related expense linked quarter expenses were down $51 million or 7%.

The decrease largely reflected lower performance base compensation marking and business services and professional fees.

Our cash efficiency ratio was 64% in the first quarter after adjusting for merger related expense, with results showing improvement from both the year ago period and the linked quarter.

Turning to slide 12, as Beth mentioned earlier, credit quality measures were impacted by the migration in our oil and gas portfolio while the rest of the portfolio has continued to perform well.

Our increased level of provision this quarter reflects the build in the reserves for oil and gas credits to 8% of outstandings.

Overall, net charge-offs were $46 million or 31 basis points of average loans in the first quarter which continues to be below our targeted range.

First quarter provision for credit losses was $89 million, an increase of $54 million from the year-ago period and $44 million from the linked quarter.

Nonperforming loans and nonperforming assets both increased relative to the prior quarter and year-ago period.

As 90% of the change was related to our oil and gas portfolio.

At March 31, 2016, our reserves loan losses represented 1.37% of period end loans and 122% coverage of our nonperforming loans.

Despite this movement that we saw in the first quarter, our outlook for credit quality remains consistent for the remainder of the year with provision levels modestly exceeding net charge-offs, which will support our continued loan growth.

The allowance as a percentage of period end loans is anticipated to be relatively stable with our first quarter level.

Turning to slide 13, our common equity tier 1 ratio was strong at March 31, 2016, at 11.11%.

We submitted our capital plan during the current quarter, which included both common share repurchases and increased dividends.

We look forward to sharing the results with you.

As previously communicated we plan to increase our common share dividend in the second quarter of this year by 13% subject to Board approval.

Moving on to slide 14, our 2016 outlook is for the stand-alone Key operations and does not reflect the impact of First Niagara nor the merger related expense.

We have updated our guidance to reflect the first quarter results.

Importantly we continue to expect the drive positive operating leverage and our outlook for the remainder of the year has not changed.

Average loans should grow in the mid single-digit range as we benefit from strength in our commercial businesses.

We now anticipate net interest income growth in the low to mid single-digit percentage range compared to 2015, without any benefit from further rate increases.

This increase in our outlook reflects the benefit from the December rate rise flowing through to the bottom line.

With the benefit of future rate increases, we would anticipate net interest income to be up in the mid single-digit range.

It's important to note that we have assumed that deposit rates will increase with future rate increases.

Non-interest income is expected to be up in the low to mid single-digit percentage range for the year, which primarily reflects weaker revenue from our market sensitive businesses in the first quarter.

We continue to expect year-over-year growth in investment banking and debt placement fees as well as other core fee-based businesses where our investments are continuing to mature, such as cards and payments.

We are also assuming very modest levels of principal investing gains in 2016.

Full-year reported expenses excluding merger related expense should be relatively stable with 2015.

We continue to expect net charge-offs to remain below our targeted range of 40 to 60 basis points.

We also expect provision levels to modestly exceed net charge-offs, which will support our continued loan growth.

The allowances percentage of period end loan is anticipated to be relatively stable with our first quarter results.

With that I'll close and turn the call back over to the operator for instructions for the Q&A portion of our call.

Shawn?

Thank you.

(Operator Instructions)

The first question will come from the line of Matt O'Connor from Deutsche Bank.

Please go ahead.

Good morning.

Good morning, Matt.

Appreciate the full-year commentary on the investment banking line and debt placement fees.

But just maybe comment on what the pipeline is coming out of the quarter and the kind of nearer-term outlook for that business.

And then I guess I always think about the corporate services line also being impacted by volume, so if you could talk to those two together, that might be best.

Sure.

Thanks, Matt.

As far as the outlook for investment banking, the pipelines are strong for us.

We would expect to see significant increases going forward from the level that we experienced in the first quarter.

We have seen markets start to return to more normal levels and saw activities pick up in March and continue into April.

So we're optimistic that we'll see some strength going forward from that.

As far as the other corporate services, that includes FX, interest rate swaps, loan fees that are not specific to the balance sheet, and we would expect to see continued good activity in that category as well.

Okay.

I guess it's one and done on the questions, so thank you.

Thanks Matt.

Our next question comes from Ken Usdin from Jefferies.

One moment.

Please go ahead.

Thanks a lot.

If could I just follow up on the expense side, Don, you're still holding out that guide for the stable year-over-year and positive operating leverage.

Does anything change with regards to the progression of expenses given the slight change in mix that you're expecting now in terms of kind of the base outlook for revenue growth in terms of your ability to keep that operating leverage gap?

If you look at the change in our outlook for revenues, it really is more reflective of what happened in the first quarter as opposed to what we would see prospectively.

So we would expect to see the compensation related expenses go up in future quarters as we see those capital markets revenues start to return to the revenue generation for us.

So we would see increases there.

We also typically would see marketing step-up from the first quarter level in future periods as well.

So we would think that we would see normal type of seasonal trends and expense levels that would be consistent with the performance that we would be generating.

Okay, thanks, Don.

Thank you.

Our next question will come from the line of John Pancari from Evercore.

Please go ahead.

Good morning.

Just wanted to ask a little bit more color around the margin.

I appreciate the spread revenue guidance you gave us, with and without rates.

How would you think about the trajectory of the margin just given if you did not see any rate hikes?

And how we should think about it through the year and going into 2017?

Just like last year what we see as the major mover as far as our margin is our relative liquidity that we have on our balance sheet.

And first quarter levels of liquidity were higher than what we would have expected going into it.

And I'll tell you that right now the second quarter is even higher than what we experienced in the first quarter.

So where we see pressure on the margin it's more from the ballooning up of that liquidity position on the balance sheet that we're seeing core performance in the other categories maintained.

And loan prices have stabilized across our footprint and so we would expect to have a relatively stable margin absent any changes in liquidity.

Okay.

But is there a plan around that excess liquidity outside of just pure loan generation?

Is there a plan around the [bomb] book or anything?

A lot of the excess liquidity comes from temporary funding from some of our commercial customers.

So we continue to want to support those customers and will work through that.

But right now, with interest rates being so low, it tends to be just more of a placement of that cash with us.

And we'll work through that over time.

But right now, we're allowing that to come through and again there really isn't much of a cost to us to maintain that.

It's just that does it dilute the margin.

Then one other question around the margin, or really around spread revenue.

Your expectation for mid single-digit growth if you do see higher interest rates, how would you define higher interest rates in that scenario?

That would include two rate increases throughout the rest of this year.

So we're not expecting that to occur right now, but that's what the baseline assumption would be for that.

Got it.

Thanks, Don.

Thank you.

(Operator Instructions)

Once again, ladies and gentlemen, please limit yourself to one question.

Our next question comes from the line of Ken Zerbe from Morgan Stanley.

Great.

Thank you.

I guess the question is just in terms of the merger expenses.

I see your guidance is excluding the merger expenses, but could you just give us an update in terms of both the timing throughout 2016 of merger costs and the potential magnitude of these expenses?

Thanks.

Sure.

Back in October when we announced the transaction we said that we expected to see about $550 million of merger related expenses.

That's still our current estimate.

And we would expect that to accelerate between now and especially the systems conversion and bank consolidations, which would be we expect to occur later this calendar year.

So sometime in the fourth quarter.

So we would expect you to see increases again in the second quarter and then again in the third and then again in the fourth.

So the majority then would be handled through middle of 2017.

But you will see an acceleration of those types of costs throughout the rest of the year.

Okay.

Thank you.

Thank you.

Our next question will come there the line of Gerard Cassidy from RBC.

Please go ahead.

Good morning, Don.

Good morning, Gerard.

Can you talk about the nonperforming assets?

I understand the energy part that you referenced, like other banks, everybody had the big increase in the energy nonperformers.

Can you give us some color on the credit performance outside of energy?

Because you indicated on slide 12 that the nonperforming loan increase, 90% was due to energy, and the remaining obviously was due to other.

Can you give us some color what the other was?

I know it's relatively small at about $29 million but what are you guys seeing outside of energy in delinquency trends?

Hi, Gerard, it's Bill Hartmann.

Hi, Bill.

So what we've seen is a few, what we'll call situation specific examples throughout the portfolio, with no discernible trend in any area.

So we've talked in the past about when you start from a low base, any number begins to look large.

So there's nothing that's any discernible trend and it's spread out.

And just as a follow-up to this, obviously the energy delinquencies and nonperformers were sure national credit driven from what we're hearing from you and all your peers.

Can you remind us, how large is your traditional participation portfolio in SNCs with the regular SNC exam that's going on right now?

How big of a portfolio of SNCs do you have, about?

And Gerard I'll go ahead and take a first crack at this and then Bill provide additional color.

But keep in mind as far as oil and gas we applied the standards that came out from the regulators at the end of the quarter across our entire oil and gas portfolio.

So even though our loans that we would agent haven't been subjected to the SNC review, we do believe that we have applied this across the entire portfolio.

As far as the oil and gas area that -- we do primarily participate in facilities that are lead by other agent banks, so we do have broader relationships with those clients and still is consistent with our overall relationship strategy.

Thank you.

Thanks.

Our next question will come from the line of Bob Ramsey from FBR.

Please go ahead.

Hi, guys.

This is actually Kyle Peterson, speaking for Bob today.

Kind of expanding on the energy a little bit, I noticed that the provision kind of ticked up $89 million there -- to $89 million this quarter.

To try to isolate what was kind of oil and gas verse the rest of the book, is a good way to think about that as kind of the same ratio as the as the MPA uptick with 90% being related to oil and gas, or is there another way we should get a handle on it?

One way to think about it would be is we maintain about 6% reserves at the end of the fourth quarter for total oil and gas.

That's increased to 8% at the end of this quarter.

We also had about $15 million worth of charge-offs in oil and gas in the current quarter.

So that essentially provides a little bit more of a walk forward as to what drove the change there.

All right, great.

That's very helpful.

Thank you.

Our next question will come from the line of Mike Mayo from CLSA.

Please go ahead.

Hi.

I'm not sure if Chris Gorman is there to give us an update on First Niagara, but on the downside when you announced the acquisition, there was a forecast for more Fed rate hikes.

And First Niagara is asset sensitive so I guess that's a negative.

On the positive side perhaps there's more than expected cost savings there since upstate New York has lower employment costs.

So if you can talk about those ins and outs, please?

Thanks.

Sure, Mike.

This is Don.

You're right, Chris is not with us in the room.

He's busy working through the integration with First Niagara.

The rates have come down.

You're absolutely right.

And we would have assessed that First Niagara's balance sheet position using our same assumptions and balance sheet mix would be very comparable to where we were from an asset sensitivity.

So I don't know that it's disproportionate impact to First Niagara compared to what we would have thought before.

As far as overall expense saves, as Beth mentioned earlier, we continue to be very confident in achieving our expense targets.

And as we've talked before our internal targets we've established are higher than what we've said externally.

That's what we're holding our teams accountable to and look to provide more color as we play through that.

How can you better capitalize on the lower cost employment base in upstate New York?

I mean, can you move jobs there?

What are some of your options?

Yes, Mike, this is Beth.

We are looking at the proximity of the two markets and how do we -- where and how we perform work.

And so there are moves afoot to look at leveraging both lower cost space, a very attractive workforce in terms of skills and tenure, as well as an attractive labor market from a cost point of view.

So we are looking at balancing out where and how work gets done as well as some of the efforts we had underway.

For example, we were in the process of standing up our mortgage capabilities and giving that First Niagara had a full fledged mortgage operation from origination through servicing, we will be building upon that in Buffalo.

So we're doing a variety of things where we look at how to optimize the portfolio of locations, work forces, and skills, in a way that I think will be beneficial to our cost synergy.

Thank you.

Thank you.

Thanks, Mike.

And our next question comes from the line of David Eads from UBS.

Please go ahead.

Good morning.

Good morning.

I was wondering if you could talk a little bit about what you're seeing in terms of deposit pricing and funding costs?

We saw that tick up a little bit this quarter, kind of across the both, on different deposit type.

Was that due to competition, or how does that interplay with -- and does that give you opportunities, I guess to bring down funding costs given the strong deposit growth you guys are showing?

As far as our deposit funding costs, it really reflects from the mix change we saw in the current period.

I would say that mix change is driven by our efforts to make sure that we can continue to grow our core retail deposit base.

And there's a lot of value for that.

Not only from the LCR perspective, but also from a core business perspective.

During the past quarter to two quarters, we've been starting to implement some targeted programs to increase time deposits along with certain money market type of products.

And had a lot of success in growing and deepening the share of wallet for those retail customers and would expect to continue to do that.

Absent those types of efforts we would expect the overall deposits remain relatively stable and haven't seen much in the way of increased aggressive deposit pricing.

You'd expect that deposit costs to be kind of stable from here, assuming no more rate hikes?

I would say relatively stable.

I think we were up 2 basis points linked quarter and so I would categorize that as in that kind of almost relatively stable type of category.

Thanks.

Thank you.

Our next question will come from the line of Matt Burnell from Wells Fargo Securities.

Please go ahead.

Good morning.

Thanks for taking my questions.

Just on the commercial loan growth, that's been a bit above some of your peers.

I guess I'm curious where you're seeing the strongest growth and are there any areas where you might, within that portfolio, begin to think about pulling back over the course of this year?

As far as where we're seeing the growth, we've talked for the last year and a half about how we've been adding senior bankers, not only in our corporate bank, but also in our community bank.

Where we've been adding those bankers is where we're seeing that incremental growth.

So we're really seeing that from picking up new relationships and growing the book based on those investments we've been making.

So we've been very pleased with that.

As far as where we've been pulling back, we've talked in the past about certain markets where we see in the multifamily housing that it's gotten a little overheated and, therefore, we've pulled back on that a little bit.

And we continue to reassess other areas of concern, but generally that's been the area where we've seen the most adjustments.

I guess I want to drill down on the other areas of concern.

Can you give a little more color there as to would parts of the portfolio are -- you're referring to?

Yes, this is Bill Hartmann.

Within the commercial portfolio, obviously we've seen the impacts in some of the manufacturing space, with the strong dollar, and some of the weakening economies.

We don't see any problems occurring in it, but the customers themselves are not experiencing the kind of growth that would lead to lending opportunities for us to expand capacity.

That's one area, as an example of where we're seeing other weakness.

Thanks very much.

Thank you.

Our next question will come from the line of Scott Siefers from Sandler O'Neill.

Please go ahead.

Good morning, guys.

Good morning, Scott.

Don, I was hoping you could spend another moment or two talking about the IB and debt placement line?

If I caught it correctly it sounds like you still expect positive year-over-year growth from that line.

So, one, did I get that correctly?

And I guess the crux of the question is, it implies that we're going to have to have a really forceful snap-back obviously.

I think you would have to average somewhere around $125 million or so per quarter in revenue.

Can you talk about sort of the pace of that build?

In other words, do we nearly double here in the 2Q, or is this going to be a slow build throughout the course of the year?

We typically don't provide quarterly specific guidance, but I will tell you that we would expect a meaningful increase from the first quarter levels to what we would see in the next several quarters.

That's based on what we're seeing from a pipeline and based on would we're seeing in activity later in the quarter and continuing in the first part of this quarter.

So I don't want to imply that it's going to be more than double from where it is in the current quarter.

But we should see a meaningful increase there.

Okay.

That sounds good.

Thank you very much.

Thank you.

(Operator Instructions)

Our next question will come from the line of Gerard Cassidy with RBC.

Please go ahead.

Thank you.

I have a follow-up for you, Beth.

Can you give us a flavor for the timeline?

Obviously you guys plan to close the deal in the third quarter.

I know there was some objections by the governor of New York to the transaction.

Can you give us any color on how the progress is going to overcome these objections, particularly that one, and to get that closing date in the third quarter?

Yes, Gerard we are tracking as you know -- the approval for the transaction will come from Department of Justice who would be reviewing divestiture requirements for competitive purposes, and then our two primary regulators, the Federal Reserve and the OCC.

So we are working through the process there very constructively, and all that is on track and on the timeline that we would have anticipated to meet a third quarter closing for the transaction.

And as it relates to other entities such as community groups, elected officials, we have been very present and had a lot of constructive dialogue.

One important piece of this was the announcement of our community benefits plan that we were successful in entering into with the NCRC on a national basis, which is a significant milestone on the community group front.

And then across other constituents, again dialogues have been constructive, proactive, and against the parties who will approve it we are tracking against the expectations we set with a third quarter close.

Great.

Thank you.

Oh, go ahead.

Thank you.

Our next question comes from Jesus Bueno from Compass Point.

Hi, thanks for taking my question.

Just want to ask quickly about your asset sensitivity.

I noticed you put on some more swaps during the quarter and you have some rolling off at the end of the year.

If you could just comment on how you're planning on managing your asset sensitivity going in the back end of this year?

Right now we're right in that 2% to 3% kind of asset sensitive range, right around 2.5%.

The swap increase reflects the increase in our LIBOR-based loans and also the fact that we issued some CDs this quarter so we had an increase in some of the fixed rate liabilities as well.

So it was more of just an overall balance sheet management and making sure that we maintain in that general range.

And still believe that we'll probably continue to maintain somewhere in that 2% to 3% type of asset sensitive range for the rest of the year.

Thanks for taking my question.

Thank you.

And currently we have no further questions in queue.

All right.

Thank you, operator.

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

If you have any follow-up questions, you can direct them to our Investor Relations team at 216-689-4221.

That concludes our remarks.

And again, thank you for your participation today.

Thank you.

Ladies and gentlemen, that does conclude our conference today.

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You may now disconnect.