KeyCorp (KEY) reported second quarter income from continuing operations of 6 cents per share, substantially better than the Zacks Consensus Estimate of a loss of 11 cents. This also compares much favorably with a net loss from continuing operations of 68 cents in the prior-year quarter.
This represents KeyCorp’s first profitable quarter since the beginning of the financial crisis in early 2008. Lower provisions for loan losses, solid expense management and higher fee income were the primary factors that helped KeyCorp bounce back to profitability after incurring significant losses for the last eight quarters.
A strong capital position and improved credit quality across the majority of the loan portfolios in both Community Banking and National Banking were also among the positives. However, pressure on the top-line, primarily as a result of lower non-interest income and declines in average earning assets and average deposits, were the downside.
Total revenues for the reported quarter came in at $1.12 billion, down 13.0% from $1.28 billion in the prior-year quarter. However, revenues were better than the Zacks Consensus Estimate of $1.08 billion.
KeyCorp’s net income from continuing operations came in at $56 million, compared to a loss of $394 million in the prior-year quarter. The results for the year-ago quarter were significantly impacted by a higher loan loss provision.
Including discontinued operations, net income for the reported quarter came in at $29 million compared to a loss of $390 million in the year-ago quarter.
Behind the Headlines
Tax-equivalent net interest income increased 8.3% year-over-year to $623 million. This increase was primarily a result of a 47 basis-points (bps) increase in net interest margin (NIM) to 3.17%, due primarily to reduced funding costs.
KeyCorp continues to experience an improvement in the mix of deposits. The improvement resulted from a lower level of high cost certificates of deposit and an increase in low-cost transaction accounts, which the company expects to continue through the remainder of 2010.
Provision for loan losses for the reported quarter was $228 million, substantially down from $823 million in the prior-year quarter. KeyCorp’s allowance for loan losses was $2.2 billion or 4.16% of total loans as of June 30, 2010, compared to $2.3 billion or 3.48% as of June 30, 2009.
Non-interest income for the quarter decreased 30.3% year over year to $492 million. The year-over-year decrease reflects a $125 million net gain from the sale of collateralized mortgage obligations, a $95 million gain related to the exchange of common shares for capital securities and a $32 million gain from the sale of the company’s claim related to the bankruptcy of Lehman Brothers in the year-ago quarter.
Non-interest expense for the quarter decreased 10.1% year-over-year to $769 million. Though personal expenses increased 2.7% year over year, a significant decrease in non-personal expenses kept overall expenses lower compared to the year-ago quarter. FDIC deposit insurance premiums decreased by $37 million from the year-ago quarter as a result of the imposition of a special assessment.
Credit Quality
Credit quality significantly improved during the quarter. Non-performing assets as a percentage of portfolio loans, other real estate owned assets as well as other non-performing assets decreased 43 bps sequentially to 3.88%. Also, net charge-offs as a percentage of average loans decreased 49 bps sequentially to 3.18%.
Capital Ratios
Capital ratios continued to improve during the second quarter of 2010. KeyCorp originated approximately $7.6 billion in new or renewed lending commitments to consumers and businesses during the quarter. KeyCorp’s tangible common equity to tangible assets ratio was 7.65% as on June 30, 2010, compared to 7.37% at the end of the prior quarter and 7.35% at the end of the prior-year quarter. Tier 1 risk-based capital ratio was 13.55%, compared to 12.92% at the end of the prior quarter and 12.57% at the end of the prior-year quarter.
While the results continue to be affected by the difficult operating environment, we expect that the business restructuring actions undertaken by the company will fuel its credit quality, capital position and liquidity.
However, there are concerns related to the impact of the finance reform bill signed recently. The bill would partially restrict proprietary trading of commercial banks. Also, derivatives trading would be restricted, which are used to hedge risk or speculate the future value of assets.
As a result, a significant impact on profitability is expected for the commercial banks including KeyCorp, Morgan Stanley (MS), Bank of America (BAC), JPMorgan Chase & Co. (JPM), Wells Fargo (WFC), Goldman Sachs (GS) and Citigroup (C).
KeyCorp currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Also, in the absence of any significant catalysts except its bouncing back to profitability, we maintain a long-term Neutral recommendation on the stock.
Since the announcement of results, the share price of KeyCorp has increased 5.7%.
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