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KEY > SEC Filings for KEY > Form 10-Q on 4-Aug-2014All Recent SEC Filings

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Form 10-Q for KEYCORP /NEW/


4-Aug-2014

Quarterly Report


Item 2. Management's Discussion & Analysis of Financial Condition & Results of Operations

Introduction

This section reviews the financial condition and results of operations of KeyCorp and its subsidiaries for the quarterly and year-to-date periods ended June 30, 2014, and June 30, 2013. Some tables may include additional periods to comply with disclosure requirements or to illustrate trends in greater depth. When you read this discussion, you should also refer to the consolidated financial statements and related notes in this report. The page locations of specific sections and notes that we refer to are presented in the table of contents.

References to our "2013 Form 10-K" refer to our Form 10-K for the year ended December 31, 2013, which has been filed with the SEC and is available on its website (www.sec.gov) or on our website (www.key.com/ir).

Terminology

Throughout this discussion, references to "Key," "we," "our," "us," and similar terms refer to the consolidated entity consisting of KeyCorp and its subsidiaries. "KeyCorp" refers solely to the parent holding company, and "KeyBank" refers to KeyCorp's subsidiary bank, KeyBank National Association.

We want to explain some industry-specific terms at the outset so you can better understand the discussion that follows.

We use the phrase continuing operations in this document to mean all of our businesses other than the education lending business, Victory, and Austin. The education lending business and Austin have been accounted for as discontinued operations since 2009. Victory was classified as a discontinued operation in our first quarter 2013 financial reporting as a result of the sale of this business as announced on February 21, 2013, and closed on July 31, 2013.

Our exit loan portfolios are separate from our discontinued operations. These portfolios, which are in a run-off mode, stem from product lines we decided to cease because they no longer fit with our corporate strategy. These exit loan portfolios are included in Other Segments.

We engage in capital markets activities primarily through business conducted by our Key Corporate Bank segment. These activities encompass a variety of products and services. Among other things, we trade securities as a dealer, enter into derivative contracts (both to accommodate clients' financing needs and to mitigate certain risks), and conduct transactions in foreign currencies (both to accommodate clients' needs and to benefit from fluctuations in exchange rates).

For regulatory purposes, capital is divided into two classes. Federal regulations currently prescribe that at least one-half of a bank or BHC's total risk-based capital must qualify as Tier 1 capital. Both total and Tier 1 capital serve as bases for several measures of capital adequacy, which is an important indicator of financial stability and condition. As described under the heading "Regulatory capital and liquidity - Capital planning and stress testing" in the section entitled "Supervision and Regulation" that begins on page 7 of our 2013 Form 10-K, the regulators are required to conduct a supervisory capital assessment of all BHCs with assets of at least $50 billion, including KeyCorp. As part of this capital adequacy review, banking regulators evaluate a component of Tier 1 capital, known as Tier 1 common equity. The section entitled "Capital adequacy" provides more information on total capital, Tier 1 capital, and Tier 1 common equity and describes how the three measures are calculated.

Additionally, a comprehensive list of the acronyms and abbreviations used throughout this discussion is included in Note 1 ("Basis of Presentation").


Table of Contents

Selected financial data

Our financial performance for each of the last five quarters is summarized in Figure 1.

                       Figure 1. Selected Financial Data



                                                                                2014                                 2013                         Six months ended June 30,
dollars in millions, except per share amounts                          Second          First         Fourth          Third         Second           2014               2013
FOR THE PERIOD
Interest income                                                       $     639      $     630      $     649      $     647      $     657     $       1,269        $   1,324
Interest expense                                                             66             67             66             69             76               133              160
Net interest income                                                         573            563            583            578            581             1,136            1,164
Provision (credit) for loan and lease losses                                 10              6             19             28             28                16               83
Noninterest income                                                          455            435            453            459            429               890              854
Noninterest expense                                                         689            662            712            716            711             1,351            1,392
Income (loss) from continuing operations before income taxes                329            330            305            293            271               659              543
Income (loss) from continuing operations attributable to Key                247            238            235            235            199               485              400
Income (loss) from discontinued operations, net of taxes (a)                (28 )            4             (5 )           37              5               (24 )              8
Net income (loss) attributable to Key                                       219            242            230            272            204               461              408
Income (loss) from continuing operations attributable to Key common
shareholders                                                                242            232            229            229            193               474              389
Income (loss) from discontinued operations, net of taxes (a)                (28 )            4             (5 )           37              5               (24 )              8
Net income (loss) attributable to Key common shareholders                   214            236            224            266            198               450              397
PER COMMON SHARE
Income (loss) from continuing operations attributable to Key common
shareholders                                                          $     .28      $     .26      $     .26      $     .25      $     .21     $         .54        $     .42
Income (loss) from discontinued operations, net of taxes (a)               (.03 )           -            (.01 )          .04            .01              (.03 )            .01
Net income (loss) attributable to Key common shareholders (b)               .24            .27            .25            .29            .22               .51              .43
Income (loss) from continuing operations attributable to Key common
shareholders - assuming dilution                                      $     .27      $     .26      $     .26      $     .25      $     .21     $         .53        $     .42
Income (loss) from discontinued operations, net of taxes - assuming
dilution (a)                                                               (.03 )           -            (.01 )          .04            .01              (.03 )            .01
Net income (loss) attributable to Key common shareholders -
assuming dilution (b)                                                       .24            .26            .25            .29            .22               .51              .43
Cash dividends paid                                                        .065           .055           .055           .055           .055               .12             .105
Book value at period end                                                  11.65          11.43          11.25          11.05          10.89             11.65            10.89
Tangible book value at period end                                         10.50          10.28          10.11           9.92           9.77             10.50             9.77
Market price:
High                                                                      14.59          14.70          13.55          12.63          11.09             14.70            11.09
Low                                                                       12.90          12.25          11.24          11.05           9.29             12.25             8.29
Close                                                                     14.33          14.24          13.42          11.40          11.04             14.33            11.04
Weighted-average common shares outstanding (000)                        875,298        884,727        890,516        901,904        913,736           879,986          917,008
Weighted-average common shares and potential common shares
outstanding (000) (c)                                                   902,137        891,890        897,712        908,253        918,628           886,684          922,319
AT PERIOD END
Loans                                                                 $  55,600      $  55,445      $  54,457      $  53,597      $  53,101     $      55,600        $  53,101
Earning assets                                                           78,457         77,692         79,467         77,085         76,717            78,457           76,717
Total assets                                                             91,798         90,802         92,934         90,708         90,639            91,798           90,639
Deposits                                                                 67,799         67,266         69,262         68,535         67,721            67,799           67,721
Long-term debt                                                            8,213          7,712          7,650          6,154          6,666             8,213            6,666
Key common shareholders' equity                                          10,213         10,112         10,012          9,915          9,938            10,213            9,938
Key shareholders' equity                                                 10,504         10,403         10,303         10,206         10,229            10,504           10,229
PERFORMANCE RATIOS - FROM CONTINUING OPERATIONS
Return on average total assets                                             1.14 %         1.13 %         1.08 %         1.12 %          .95 %            1.13 %            .97 %
Return on average common equity                                            9.55           9.33           9.10           9.13           7.72              9.44             7.84
Return on average tangible common equity (d)                              10.60          10.38          10.13          10.18           8.60             10.49             8.73
Net interest margin (TE)                                                   2.98           3.00           3.01           3.11           3.13              2.99             3.18
Cash efficiency ratio (d)                                                  65.8           64.9           67.4           67.5           69.1              65.4             67.5
PERFORMANCE RATIOS - FROM CONSOLIDATED OPERATIONS
Return on average total assets                                              .96 %         1.09 %         1.00 %         1.22 %          .92 %            1.03 %            .93 %
Return on average common equity                                            8.44           9.50           8.90          10.61           7.92              8.96             8.00
Return on average tangible common equity (d)                               9.37          10.56           9.91          11.82           8.82              9.96             8.91
Net interest margin (TE)                                                   2.94           2.95           2.91           3.06           3.07              2.95             3.12
Loan to deposit (e)                                                        87.1           87.5           83.8           83.8           83.6              87.1             83.6
CAPITAL RATIOS AT PERIOD END
Key shareholders' equity to assets                                        11.44 %        11.46 %        11.09 %        11.25 %        11.29 %           11.44 %          11.29 %
Key common shareholders' equity to assets                                 11.13          11.14          10.78          10.94          10.96             11.13            10.96
Tangible common equity to tangible assets (d)                             10.15          10.14           9.80           9.93           9.96             10.15             9.96
Tier 1 common equity (d)                                                  11.25          11.27          11.22          11.17          11.18             11.25            11.18
Tier 1 risk-based capital                                                 11.99          12.01          11.96          11.92          11.93             11.99            11.93
Total risk-based capital                                                  14.14          14.23          14.33          14.37          14.65             14.14            14.65
Leverage                                                                  11.24          11.30          11.11          11.33          11.25             11.24            11.25
TRUST AND BROKERAGE ASSETS
Assets under management                                               $  39,669      $  38,893      $  36,905      $  36,110      $  35,544     $      39,669        $  35,544
Nonmanaged and brokerage assets                                          48,728         47,396         47,418         38,525         37,759            48,728           37,759
OTHER DATA
Average full-time-equivalent employees                                   13,867         14,055         14,197         14,555         14,999            13,961           15,197
Branches                                                                  1,009          1,027          1,028          1,044          1,052             1,009            1,052

(a) In April 2009, we decided to wind down the operations of Austin, a subsidiary that specialized in managing hedge fund investments for institutional customers. In September 2009, we decided to discontinue the education lending business conducted through Key Education Resources, the education payment and financing unit of KeyBank. In February 2013, we decided to sell Victory to a private equity fund. As a result of these decisions, we have accounted for these businesses as discontinued operations. For further discussion regarding the income (loss) from discontinued operations, see Note 11 ("Acquisitions and Discontinued Operations").

(b) EPS may not foot due to rounding.

(c) Assumes conversion of common share options and other stock awards and/or convertible preferred stock, as applicable

(d) See Figure 7 entitled "GAAP to Non-GAAP Reconciliations," which presents the computations of certain financial measures related to "tangible common equity," "Tier 1 common equity," and "cash efficiency." The table reconciles the GAAP performance measures to the corresponding non-GAAP measures, which provides a basis for period-to-period comparisons.

(e) Represents period-end consolidated total loans and loans held for sale (excluding education loans in the securitizations trusts) divided by period-end consolidated total deposits (excluding deposits in foreign office).


Table of Contents

Forward-looking statements

From time to time, we have made or will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements do not relate strictly to historical or current facts.
Forward-looking statements usually can be identified by the use of words such as "goal," "objective," "plan," "expect," "anticipate," "intend," "project," "believe," "estimate," or other words of similar meaning. Forward-looking statements provide our current expectations or forecasts of future events, circumstances, results or aspirations. Our disclosures in this report contain forward-looking statements. We may also make forward-looking statements in our other documents filed with or furnished to the SEC. In addition, we may make forward-looking statements orally to analysts, investors, representatives of the media, and others.

Forward-looking statements, by their nature, are subject to assumptions, risks, and uncertainties, many of which are outside of our control. Our actual results may differ materially from those set forth in our forward-looking statements. There is no assurance that any list of risks and uncertainties or risk factors is complete. Factors that could cause actual results to differ from those described in forward-looking statements include, but are not limited to:

deterioration of commercial real estate market fundamentals;

defaults by our loan counterparties or clients;

adverse changes in credit quality trends;

declining asset prices;

changes in local, regional and international business, economic or political conditions;

the extensive and increasing regulation of the U.S. financial services industry;

changes in accounting policies, rules and interpretations;

increasing capital and liquidity standards under applicable regulatory rules;

unanticipated changes in our liquidity position, including but not limited to, changes in the cost of liquidity, our ability to enter the financial markets and to secure alternative funding sources;

our ability to receive dividends from our subsidiary, KeyBank;

downgrades in our credit ratings or those of KeyBank;

breaches of security or failures of our technology systems due to technological or other factors and cybersecurity threats;

operational or risk management failures by us or critical third-parties;

adverse judicial proceedings;

the occurrence of natural or man-made disasters or conflicts or terrorist attacks;

a reversal of the U.S. economic recovery due to financial, political or other shocks;

our ability to anticipate interest rate changes and manage interest rate risk;

deterioration of economic conditions in the geographic regions where we operate;

the soundness of other financial institutions;


Table of Contents
our ability to attract and retain talented executives and employees and to manage our reputational risks;

our ability to timely and effectively implement our strategic initiatives;

increased competitive pressure due to industry consolidation;

unanticipated adverse effects of acquisitions and dispositions of assets or businesses;

our ability to develop and effectively use the quantitative models we rely upon in our business planning; and

other risks and uncertainties discussed in the section "Supervision and regulation" in Item 2 of this report, and Part I, Item 1. Business under the heading "Supervision and Regulation" and Item 1A. Risk Factors in our 2013 Form 10-K.

Any forward-looking statements made by us or on our behalf speak only as of the date they are made, and we do not undertake any obligation to update any forward-looking statement to reflect the impact of subsequent events or circumstances. Before making an investment decision, you should carefully consider all risks and uncertainties disclosed in our SEC filings, including our reports on Forms 8-K, 10-Q, and 10-K, and our registration statements under the Securities Act of 1933, as amended, all of which are or will upon filing be accessible on the SEC's website at www.sec.gov and on our website at www.key.com/ir.

Economic overview

The economy began to recover in the second quarter of 2014, as real gross domestic product ("GDP") grew by an annualized 4% after a very disappointing first quarter. The improvement, however, has been modest, with data clearly more positive but often lagging expectations. Manufacturing data is showing the fundamentals necessary for a strong recovery, but the housing market remains mixed, with slow growth in residential construction and sales of both new and existing homes falling below year-ago levels. Consumer spending growth has remained modest, as very strong job growth has yet to translate into substantial wage growth, although consumers are now more confident than they have been since the Great Recession. Geopolitical tensions, prospective Federal Reserve actions, and mixed economic data for the most part kept markets in check throughout the second quarter.

In the second quarter, weak income growth remained an important constraint on consumption, although fundamentals appear to be strengthening. Real spending dropped for the second consecutive month in May 2014, led by declines in nondurable goods and services spending. Vehicle sales surged to an average of 16.5 million units in the second quarter of 2014, a jump from the 15.6 million units recorded in the first quarter of 2014. Retail sales were modest for the quarter, although showed a marked improvement from first quarter weakness. Consumer confidence increased, with the Conference Board measure ending the second quarter at 85.2%, up 3.0 points month-over-month to the highest level in over six years. Price gains accelerated, with the consumer price index finally eclipsing the 2% mark in April, and stayed there for consecutive months, driven by increases in energy and food prices. The core personal consumption expenditure index was up 1.5% year-over-year as of May 2014.

In the labor market, average monthly job gains rose to 272,000 during the second quarter of 2014, compared to average gains of 190,000 in the first quarter of 2014. Gains were across all job sectors and reflect a strong recovery in the labor market after a rough first quarter. The unemployment rate decreased sharply, finishing the quarter at 6.1%, driven by a 479,000 gain in household employment coupled with a 533,000 decrease in the labor force. Despite the improved health of the labor market, participation remains historically low at 62.8% as of June 30, 2014.

The housing market continues to be mixed, with different results between indicators and month-to-month. In June 2014, existing home sales eclipsed 5 million units for the first time since October 2013 but remained below year-ago levels. New home sales were disappointing, with an 11.5% year-over-year decrease in June 2014. Housing starts have yet to pick up, totaling a seasonally adjusted annual rate of 893,000 in June 2014, up 7.5% year-over-year but missing estimates significantly. Permits decreased, driven by multi-family data. Home price appreciation is slowing, with the CoreLogic Home Price Index up only 8.8% year-over-year in May 2014.

The Federal Reserve continued tapering of asset purchases in the second quarter, reducing purchases by $10 billion for the fifth consecutive meeting to a current pace of $35 billion per month. However, mixed economic data, geopolitical tensions, and cautious forward guidance by the Federal Reserve have kept rates in check. The yield on the 10-year U.S. Treasury started the quarter at 2.77%, and slowly declined throughout the quarter, ending at 2.53%. At the current pace, the latest quantitative easing program ("QE3") will end in the fourth quarter of 2014, with the federal funds rate not expected to increase until mid-to-late 2015.


Table of Contents

Long-term financial goals

Our long-term financial goals are as follows:

Target a loan-to-core deposit ratio range of 90% to 100%;

Maintain a moderate risk profile by targeting a net loan charge-off ratio range of .40% to .60%;

Grow high quality and diverse revenue streams by targeting a net interest margin in excess of 3.50%, and a ratio of noninterest income to total revenue of greater than 40%;

Create positive operating leverage and target a cash efficiency ratio in the range of 60% to 65%; and

Achieve a return on average assets in the range of 1.00% to 1.25%.

Figure 2 shows the evaluation of our long-term financial goals for the second quarter and first six months of 2014.

             Figure 2. Evaluation of Our Long-Term Financial Goals



KEY Business Model       Key Metrics (a)         2Q14        YTD 2014         Targets                     Action Plans
Core funded              Loan to deposit            87 %            87 %         90-100 %           Use integrated model to grow
                            ratio (b)                                                                relationships and loans
                                                                                                    Improve deposit mix

Maintain a            NCOs to average loans        .22 %           .18 %        .40-.60 %           Focus on relationship clients
moderate risk                                                                                       Exit noncore portfolios
profile                Provision to average        .07 %           .06 %                            Limit concentrations
                              loans                                                                 Focus on risk-adjusted returns

Growing high           Net interest margin        2.98 %          2.99 %         > 3.50 %           Improve funding mix
quality, diverse                                                                                    Focus on risk-adjusted returns
revenue streams       Noninterest income to         44 %            44 %           > 40 %           Grow client relationships
                          total revenue                                                             Capitalize on Key's total
                                                                                                     client solutions and
                                                                                                     cross-selling capabilities

Creating positive     Cash efficiency ratio         66 %            65 %          60-65 %           Improve efficiency and
operating leverage             (c)                                                                   effectiveness
                                                                                                    Better utilize technology
                                                                                                    Change cost base to more
                                                                                                     variable from fixed

Executing our        Return on average assets     1.14 %          1.13 %      1.00-1.25 %           Execute our client
strategies                                                                                           insight-driven relationship
                                                                                                     model
                                                                                                    Focus on operating leverage
                                                                                                    Improved funding mix with lower
                                                                                                     cost core deposits

(a) Calculated from continuing operations, unless otherwise noted.

(b) Represents period-end consolidated total loans and loans held for sale (excluding education loans in the securitization trusts) divided by . . .

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