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Executives

Henry Meyer – Chairman & CEO

Jeff Weeden – CFO

Chuck Hyle – Chief Risk Officer

Analysts

Brian Foran – Goldman Sachs

Jeff Davis – Howe Barnes

Gerard Cassidy – RBC Capital Markets

David Knutson – Legal and General

KeyCorp (KEY) Q1 2009 Earnings Call Transcript April 21, 2009 9:00 AM ET

Operator

Good day and welcome to KeyCorp's first quarter 2009 earnings results conference call. This call is being recorded. At this time 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.

Henry Meyer

Thank you, operator. Good morning and welcome to KeyCorp's First Quarter 2009 Earnings Conference Call.

Joining me for today's presentation is our CFO, Jeff Weeden and available for the Q&A portion of the call are our Vice Chairs, Beth Mooney, and Peter Hancock, our Chief Risk Officer, Chuck Hyle, and our Treasurer Joe Vayda.

I hope you all look at Slide #2 which is our forward-looking disclosure statement. It covers our presentation materials and comments as well as the Q&A segment of our call today.

Now if you turn to Slide #3, today, we announced net loss of $1.09 per share for the first quarter. As was the case for the fourth quarter of last year, the loss was primarily attributable to a non-cash accounting charge for goodwill impairment and continued building of a loan loss reserve.

In light of the prevailing economic environment during the first quarter of this year, we continued to build our loan loss reserve by taking a $875 million provision for loan losses which exceeded our net charge-offs by $383 million. At March 31, 2009, our loan loss reserve stood at almost $2.2 billion and represented 2.97% of period end loans and 126% of nonperforming loans.

In our earnings release this morning, we announced that the Board of Directors intends to reduce the quarterly common stock dividend from $6.25 per share to a penny per share commencing in the second quarter. Obviously, no one likes having to reduce the dividend again. However, given the current operating environment, I, my management team and our Board believe this action is prudent. As a result of this decision, the Company will retain approximately 100 million of capital on an annual basis.

These are challenging times and operating expenses in the form of higher collection cost and deposit insurance are impacting everyone in the industry is addressing the challenges by continuing to focus on controlling costs where we can. In the first quarter, we took some additional measures to reduce costs.

And in the past year, we have reduced FTEs by approximately 1,000. Many of these reductions were associated with businesses we previously announced we were exiting or deemphasizing such as private student lending and the home builder lending area with the national banking.

In other areas of the company we are achieving better cost efficiencies by developing new technology. We are also capitalizing on our efficiencies in our commercial mortgage servicing area where we recently bid on and won an additional $3 billion of servicing.

It's continued to move forward with this business plans to reshape the company and return to profitability as the economy begins to improve. However, we are not sitting around waiting for this to happen on its own. We continue to look for ways to streamline our operations by further eliminating lower value activities and capitalizing on investments we've made to improve our operations.

At March 31, 2009, our tier one capital ratio was a strong 11.16%. Our total capital ratio stood at 15.11% and a ratio that everyone seems to be focusing on these days are tangible common ratio was 6.06%.

We remain focus on the strategic allocation of our capital during these economically challenging times. As a result, we continued to make progress on our efforts to reshape our business mix by exiting low return and indirect portfolios. However, progress here has been slower than we would have liked simply because of the malaise hanging over the economy for the past several quarters.

We have also focused our people on working with our clients to meet their funding needs while getting fairly compensated for the capital and funding we put to work. As highlighted in our earnings release, in the first quarter, we entered into new extensions of credit with clients representing approximately 7.8 billion in new or renewed loan commitments.

We remain encouraged by the results we have seen coming from the Community Bank from the investments we are making in technology, branch monetization and de novo branches. As of March 31st we have completed our rollout of Teller 21 across the company, monetized over 100 locations and we have plans to complete between 35 de novo branches and 40 de novo branches in 2009.

Last week and yesterday again, we announced internally additional changes to our organization. Within our real estate capital business we have announced we are consolidating several of our national sales locations within the income property segment and we are signing new resources to work on more challenging credits.

Within the Community Bank, we are making a series of changes that will help build greater consistency across our districts in order to have better alignment to the clients we serve and do so in a more cost-effective way.

And as always, we will continue to keep our clients at the center of everything we do in order to provide the great client experience that earn KeyCorp recognition at the top rated bank in customer service by business week and as customer service champion in 2009 edition.

We are honored to receive this recognition which adds Key ranked the 11 out of the top 25 companies that include many who are well known for their customer service acumen.

As you will also see in the appendix of our materials today, we have combined our Northwest and Rocky Mountain regions under one leadership team in order to optimize our efforts and focus on these attractive growth markets. We now have approximate 1/3rd of our company's deposits located in each of our regions. I will turn the call over to Jeff for a review of our financial results.

Jeff Weeden

Thank you, Henry. Slide #4 provides a summary about the Company's first quarter 2009 results. And as Henry mentioned we incurred a net loss of $1.09 for common share for the quarter. Impacting the first quarter results were the continued building of the reserve for loan losses in excess of net charge-offs and the 223 million or $0.38 per share non-cash charge we took for intangible asset impairment in our national banking operations.

With this latest impairment charge we have now written off all of the remaining goodwill assigned to this business unit as of March 31st 2009. This charge did not impact our regulatory or tangible capital ratios.

We included a more extensive list of items impacting our first quarter results on Page #2 of today's earnings release.

Turning to Slide #5 the Company's net interest margin was 2.77% for the first quarter of 2009 compared to an adjusted 2.84% for the fourth quarter of 2008. As the first quarter progressed, we experienced an improving margin in the back half of the quarter as lower spread assets matured and repricing for deposits began to ease somewhat in our markets.

While higher levels of nonperforming assets will keep pressure on the net interest margin we believe we will see greater stability in the margin and the possibility for expansion in coming quarters as assets continue to reprice to improve credit spread.

Turning to Slide #6, the loan categories on this slide have been adjusted for the exit portfolio shown. For example, the Marine and RV floor plan loans on this slide have been removed from the commercial, financial and agricultural loans, CF&A totals for all periods and are reflected in the exit portfolio details.

As we discussed in our fourth quarter earnings call, Key experienced an increase in loan draws in the summer and fall of 2008 as the credit markets froze up. As these markets began to show improvement late last year and continuing into 2009 corporate customers began returning to the commercial paper markets as well as holding less excess liquidity on their balance sheets due to the uncertainties surrounding the debt capital markets.

As a result, during the first quarter the Company experienced a $1.6 billion decrease in average total loan balances compared to the fourth quarter of 2008. Compared to the first quarter of last year, average total loans are up 2.6 billion or 3.6%.

The Company continued to experience growth in our community banking home equity loans with average balances up 236 million or 2.4% on annualized from the fourth quarter and 580 million or 6% from the first quarter of last year.

Turning to Slide #7 average domestic deposits increased 800 million or 1.3% on annualized from the fourth quarter. Average deposits are up 3.7 million or 6.1% from the same period one year ago. During the first quarter we continued to see a shift out of MMDA into certificates of deposits as consumers moved out on the yield curve to lock in higher deposit rates.

In addition, we also experienced an increase in DDA balances primarily from our corporate client base businesses offset some of their – as corporate customers offset some of their transaction service charges by maintaining higher amounts on deposit.

Slide #8 shows a number of asset quality measures and the trends we have experienced over the last five quarters. As we continue to move further into the credit cycle, we are also seeing additional increases in NPAs, net charge-offs and the reserve for loan losses.

Net charge-offs in the first quarter were 2.65% of average total loans, which is up from 1.77% experienced in the fourth quarter of 2008. This increase primarily occurred in our CF&A and CRE portfolios within our national banking reporting unit. The increase in CF&A loan net charge-offs was related to businesses type to commercial real estate within the commercial real estate line of business.

Net charge-offs related to floor plan lending in our consumer finance business line and small ticket commercial loans within the equipment finance line of business also remain elevated in the first quarter and are expected to remain elevated until the consumer spending increases resulting in an improved outlook for the economy.

We also experienced an increase in nonperforming loans and nonperforming assets in the first quarter. Nonperforming assets were up 533 million in the first quarter following the increase of 225 million in the fourth quarter of 2008. 86% of the increase in NPAs came from our national banking business units.

As of March 31, 2009 nonperforming assets represented 2.70% of total loans other real estate owned and other nonperforming assets. As we discussed earlier, we continue to build reserves during the first quarter. At March 31, 2009, our reserve balance stood at 2.186 billion and represented 2.97% of total loans and 126% of nonperforming loans. In the past year, we have increased the reserve for loan losses by approximately $900 million.

On Slide #9 we provide a breakdown of our credit statistics by portfolio for the first quarter. This slide provides additional information with respect to our various portfolios by classification type. We have also included in the appendix section of our materials today additional information with respect to our home equity loan portfolio and our residential property segment and retail property segment within the commercial real estate portfolio.

As I mentioned when discussing the previous slide, the two areas where we experienced the majority of our increase in net charge-offs and NPLs in the current quarter are in our CF&A and CRE portfolios. Here again we have provided additional information with respect to these portfolios in the appendix.

During the first quarter we experienced an increase in net charge-offs from the fourth quarter in our CF&A portfolio of $113 million; $232 million or 3.56% annualized of average balances. 106 million of this increase was related to commercial real estate exposures in our commercial real estate business unit.

In addition, commercial real estate construction loans experienced an increase in net charge-offs for the first quarter versus the fourth quarter of last year of $55 million. All other categories of loan showed little change from the prior quarter levels.

Slide #10 provides an updated view of our commercial real estate portfolio at March 31, 2009 by property type, by geographic location. For more than a year now we have been reporting on the detail surrounding the residential property segment of commercial real estate and will continue to provide more detail breakdown of the property types and geographic locations of the projects in the appendix materials.

One thing I would mention here is that our outstanding balances in the residential property segment have been reduced by approximately 50% over the past 12 months and now represent 10% of total outstanding balances compared to 19% of total commercial real estate outstanding balances one year ago.

As we have moved further into the economic cycle and presumably closer to the bottom of the decline in GDP, we are experiencing deterioration in other segments such as the retail property group which is dependent upon consumer spending to generate support rents.

We are working with our customers in this segment as their projects come to completion to find solution for their permanent financing needs. In a number of cases where permanent financing is simply not currently available in the market we are structuring interim financing on our balance sheet and obtaining additionally of equity from the developer to remargin and extend the loan.

As I mentioned earlier we have provided a more detailed breakdown of the retail property segment portfolio in the appendix.

Slide #11 is an overview of our exit portfolios at March 31, 2009. These portfolios which total 9.1 billion at March 31, represented 12.1% of total loans, and loans held for sale and accounted for 28.3% of first quarter net charge-offs and 25.1% of nonperforming assets. These portfolios continue to be worked down during the first quarter and overall asset quality remains stable with the fourth quarter level albeit at elevated levels.

And finally, turning to our capital ratios on Slide #12 we remain well capitalized by any regulatory measure. In our tangible equity to tangible asset ratio was a strong 9.23%. Excluding the TARP capital from this ratio, our tangible capital ratio was 6.74% and our tangible common equity to tangible asset ratio was 6.06% at March 31, 2009. We believe these ratios and the quality of the capital will compare favorably to our peers at March 31, 2009.

That concludes our formal remarks. Now I'll turn the call back over to the operator to provide instructions for the Q&A segment of our call. Operator?

Question-and-Answer Session

Operator

(Operator instructions). Let's begin with Brian Foran with Goldman Sachs.

Brian Foran – Goldman Sachs

Good morning, guys. How are you?

Jeff Weeden

Good.

Henry Meyer

Good morning.

Brian Foran – Goldman Sachs

I guess you have the $675 million convertible preferred outstanding and then the credit environment is obviously becoming increasingly tough. And then I guess is a third moving part you obviously have the stress test results coming up. Is that security in your mind one that's likely to be proactively converted to further strengthen the common equity component of your capital base?

Jeff Weeden

Brian, this is Jeff Weeden. We are certainly looking at all the different opportunities that maybe out there. And that is one that we have had discussions on with respect to the conversion of that particular security.

Brian Foran – Goldman Sachs

And then I guess is a follow-up when we look at some of the deterioration in NPAs, one of the issues you highlighted in the past is the liquidity issue on the commercial real estate side both commercial construction and commercial mortgages and the need to I guess re-underwrite some of these loans and keep them on your balance sheet. When we look at the jump-in in construction and commercial mortgage NPAs, can you give us a sense of how much of this is loans that otherwise would have rolled off your balance sheet in a normal credit environment and maybe are moving to nonperforming because of that and how much of it is just term loans on your balance sheet that would have gone bad no matter what credit environment – no matter what liquidity environment we were at?

Chuck Hyle

This is Chuck Hyle. I think that its, it's not – it's a bit of a split. Some of the larger names, we have a couple in particular that show up on the CF&A category that are clearly impacted by liquidity. These are major names that have access to the capital markets or at least used to have access to the capital markets. I think those are loans that would have, not be in the position they are in as an NPA if we had that liquidity in the business. I think most of the others in the CRE category, where we are able to refinance the asset in a logical way by either remargining or dealing with the developer in an appropriate way, those we're getting refinanced, those that clearly are impaired are moving into the NPA and charge-off categories. So it's a bit of a split.

Brian Foran – Goldman Sachs

Thank you.

Operator

(Operator instructions) We'll go next to Jeff Davis with Howe Barnes.

Jeff Davis – Howe Barnes

Good morning.

Henry Meyer

Good morning, Jeff.

Jeff Davis – Howe Barnes

Chuck, maybe I know loss rates e-log [ph] book out of the community bank are almost to minimus relative to where we are in the cycle maybe if you can comment on how you would expect that to play out over the next four quarters, five quarters, and not on employ rising unemployment impacts, it will not impact that maybe the industry. And then secondly, as it relates to the exit portfolio and then maybe liquidity generally, are things loosening up here in the last month or so that the ability to monetize assets looks like it's going to get better going forward?

Chuck Hyle

Jeff, on the first point, I would say, our home equity portfolio is continuing to perform as we have expected. We've seen a little bit of an increase in deterioration, although our early stage delinquencies in that category have actually improved. So, I think that March was a better month. And our LTVs, while they deteriorated a little bit from underwriting timeframe, where we are normally sort of 70% LTV, those have probably moved up to sort of 74%, 75% across the entire portfolio. We're clearly as we've reported in previous quarters seeing more deterioration in Ohio and the Midwest than in some of the other geographic locations, but our expectation is that this portfolio, which as you know, is pretty seasoned, originated over a long period of time, we don't have the LTV issue as some of the other regions do have and our expectation is that will carry on pretty much in the range that we have talked in the past. You have seen a little bit of an uptake in the utilization but it's fairly minor and overall, we are relatively happy with that portfolio.

As far as second question is concerned, we haven't seen much change in liquidity in the held for sale side. We are very happy to put our commercial real estate portfolio out last spring. We had good activity through the summer and into the autumn. But in the first quarter I would say that liquidity was deminimus. I think we might have sold one transaction. And we don't see a lot of volume – particularly in the residential space we don't see a lot of volume in that through the end of the first quarter.

Jeff Davis – Howe Barnes

Chuck, let me ask one quick follow-up. Is that a function of just pricing is not acceptable to you all or is it a function of markets are still locked up, we now have the overlay of whatever the treasuries legacy security purchase program is going to do to the markets?

Chuck Hyle

Bit of both, Jeff. I would say that in the residential single family home space there is just no market. Everybody is waiting. And one or two of the other real estate space, there is some activity, and then it gets down to whether we like the price and we think it's better to hold on to them. But I would say overall the liquidity is pretty sparse.

Jeff Davis – Howe Barnes

Thank you.

Operator

We'll go next to Gerard Cassidy with RBC Capital Markets.

Gerard Cassidy – RBC Capital Markets

Thank you. Good morning, guys. Could you tell us – you mentioned I think that some of the construction loans cannot find permanent financing and you've issued many (inaudible) when you rewrite the loan to put it into the commercial mortgage portfolio. What was the dollar amount of that in the quarter? And do you continue to see that as a source of funding these construction loans throughout the year if they cannot find financing?

Jeff Weeden

Gerard, this is Jeff Weeden. At the end of the quarter we had moved to approximately $1.3 billion of loans that went out of – that the completed construction and moved into the mortgage portfolio at that particular point in time.

Gerard Cassidy – RBC Capital Markets

Okay. And could you give us a little color on what types of property types? It was mostly in retail or mostly in office or whatever?

Jeff Weeden

Well, it was spread across a range of properties, certainly some retail, some office, and some warehouse. So it's pretty much a mix of asset classes.

Gerard Cassidy – RBC Capital Markets

I see. And are all of the loans that have been moved over they would stand your credit underwriting test so that these aren't trouble debt restructurings or anything like that? These are legitimate new mortgages that you are comfortable with?

Jeff Weeden

Absolutely. We wouldn't do it otherwise and these tend to be with your larger and better developers that have other assets and if it doesn't underwrite to our standards, we don't do it.

Gerard Cassidy – RBC Capital Markets

Okay. The other question was I think you guys in the non-performing asset slide that you have given us – I think it was on page 25, you mentioned that you've got some loans held for sale to dispose of. Can you tell us are those mark-to-market the ones that are held for sale? And if so, what have you marked them to market to relative to original balance?

Jeff Weeden

Yes. They are mark-to-market. Most of those, the $72 million that's in that particular outstanding balance at the end of the first quarter were from the original sale that we announced last year in the second quarter. And there's a schedule if you look at on page 27, it actually does the roll forward of that particular balance amount. But we've continued to mark those down and they're basically mark down to around the $0.40 on the dollar on average.

Gerard Cassidy – RBC Capital Markets

And are you finding that at those levels they are readily salable, that's a pretty good mark at this point in time?

Jeff Weeden

Well, we continue to take write-downs on them each, you can kind of follow the progression on that slide 27, but we continue to work those, Chuck and his team work them very, very hard each and every quarter, but again it's a matter of how much liquidity is actually in the marketplace and what are we seeing for indication of values.

Chuck Hyle

Again Gerard, because this – most of those assets are in the residential space, as I said earlier, we don't have a – we're not seeing a lot of liquidity there.

Gerard Cassidy – RBC Capital Markets

I see. And regarding the exit portfolio what are you guys – I mean, you're making steady progress obviously in reducing that portfolio. What seems to be a constraint to see even better progress? Is it pricing or is it the lack of financing that the potential buyers would need to find to buy these loans? What would accelerate it I guess?

Henry Meyer

Well, Gerard, it's Henry. We have – I have been little disappointed in the progress there and I think in almost every case, it's the lack of ability by the current borrower to find another take out. Still as you can see a lot of, these are performing loans, it's a strategic decision, but there aren't a lot of alternatives for these borrowers. Most of the reductions are the scheduled pay-downs, but we had hoped that getting out of the business would send some of those borrowers to an institution that was actively in that business and we haven't seen as much of that as we would have liked.

Gerard Cassidy – RBC Capital Markets

Great. And then one final question. Thank you for giving us the detail on the commercial real estate retail properties that you did this quarter. Could you – two questions. One, just define for us power center, what type of retailers are in the power center? And second you've done it in the past with your resi exposure pointing out that the California and Florida markets were weaker than most parts of the country. Where are the weaker spots regionally that you guys have seen in the commercial retail properties? Is it California and Florida again or is it somewhere else?

Henry Meyer

Gerard, the power centers are going to be your big box shopping centers. So if you go and see some of the larger – like a Wal-Mart, Target, Best Buy, you see a number of those very large retailers that are located in those particular centers. And clearly, what we see is this the – if you look at the schedule, obviously on page 23, you will see that the Southeast has some of the softer areas. It doesn't appear to be in Florida. It's more within the Carolina's and Georgia.

Chuck Hyle

And a bit in the southwest as well I think.

Gerard Cassidy – RBC Capital Markets

I see. Thank you.

Operator

(Operator instructions). We'll go next to David Knutson with Legal and General.

David Knutson – Legal and General

Hi, good morning. With Timothy Geithner's comments regarding loan underwriting standards being part of the criteria, what would be your company's view towards a shared national credit – Key traditionally has had relatively higher percentage of loan assets in the shared national credit program. Someone say that it's not direct origination or the underwriting is somewhat different?

Chuck Hyle

This is Chuck Hyle. Our percentage of our wholesale portfolio that is shared national credit really hasn't changed much in the last several years. I would say that we've got something like $7 billion – little over $7 billion where we are a participant in shared national credit and we lead about $1.3 billion. So that's about a third of our wholesale C&I portfolio and that percentage really has not changed in two years or three years. So that's been pretty consistent.

David Knutson – Legal and General

Okay. A follow-up would be on the student loan portfolio. The delinquencies are increasing relative to the recent past especially in private student lending. What's the company's view regarding reserve or provision requirements for that portfolio?

Chuck Hyle

Well, I think you see the reserve build up on the portfolio just simply looking at slide 9; we break everything out by portfolio. So, you'll see that the reserves are currently on that particular book of business standing at $170 million and represent 4.59%. Charge-offs are running on that entire book at about 3.5% right now. They have actually been relatively stable in the last couple of quarters. We do believe that student loans in the lending portfolio will track basically with the overall health of the consumer. So it's not unexpected that you would see a rise in delinquencies if unemployment, et cetera continues to increase.

David Knutson – Legal and General

Thank you.

Operator

We currently have no further questions at this time. I would like to turn the call back over to Mr. Henry Meyer.

Henry Meyer

Thank you, operator. And I'd like to thank all of you for taking your time from your busy schedules to participate on our call today. If you have any follow-up questions on the items we discussed, please call Vern Patterson, our Head of Investor Relations at 216-689-0520. That concludes our remarks and I hope everyone has a great day.

Operator

This does conclude today's conference call. We thank you for your participation.

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