KeyCorp strives to shrink balance sheet and refocus on key customers

KeyCorp’s net profit was down 50% year over year, prompting CEO Chris Gorman to describe the company as “under-earning”.

Kim Raff/Bloomberg

Cleveland-based KeyCorp is shrinking its balance sheet to accommodate what Chairman and CEO Chris Gorman predicts will be significantly lower expectations for loan-to-deposit ratios at big banks.

“I think the loan-to-deposit ratios for [banks with more than $100 billion in consolidated assets]if they’re in the mid-80s now, they’re going to be a lot less, and we’re very focused on that,” Gorman said Thursday in a conference call with analysts.

Key’s loan-to-deposit ratio was 83% as of June 30, down from 84.4% three months earlier.

Cleveland-based KeyCorp, the holding company of KeyBank, started the year with loan growth expectations of up to 9%, but reversed course after a tumultuous spring that saw four major banks close or fail. “We not only stopped that growth, but actually pushed it back a billion dollars” through the end of the second quarter, Gorman said. “Right now what we’re doing is we’re looking at every wallet we have in the bank.”

Chris Gorman

Chairman and CEO of KeyCorp, Chris Gorman.

As part of the reduction efforts, the $178.8 billion asset key will seek to eliminate what Gorman called “stand-alone loans” that “do not return their cost to capital.”

“If you think you have to carry more capital and you think about the capital you have [being] much more expensive, then you can be sure there will be a lot of credit-only relationships that aren’t strategic to us,” Gorman said.

Going forward, Key will not necessarily reduce loan originations. What it will seek to do is securitize and sell more loans to non-core borrowers, chief financial officer Clark Khayat said on the call. Key plans to be “more of a generator of fees, advice and basic banking services than a loan store,” Khayat said.

Although Gorman did not make an explicit link, banking regulators are expected to unveil a series of rules in the coming weeks and months that some experts say will leave many large financial institutions with little choice but to reduce their balance sheets. At least one other systemically important institution, Charlotte, North Carolina-based Truist, with $555 billion in assets, said Thursday it also plans to cut low-yielding single-product loans in favor of greater focus on major customers.

For Key, talk of a smaller balance sheet came amid a tough second-quarter earnings report. Net income was down 50% year-over-year to $250 million, prompting Gorman to call the company “under-earners.”

Gorman was quick to add that he expects Key’s earnings situation to improve significantly in 2024 and 2025, as a portfolio of short-term swaps and Treasury bills slashed net income by $340 million for the quarter ending June 30. “What we really need is the position that we have – which is responsive to responsibility at a time when you wouldn’t want to be responsive to responsibility – we need that to go, and the passage of time will do a lot on that,” Gorman said.

According to Gorman and Khayat, the price review process will result in about $225 million in additional quarterly net interest income starting in 2025.

Key’s swap and cash issues, along with higher funding costs, led to an 11% year-over-year decline in second-quarter spread revenue, which totaled $986 million. Sluggish investment banking fee revenue, which fell 20% to $120 million, contributed to a 12% year-over-year decline in non-interest revenue.

Gorman said he’s confident investment banking revenue will grow in the second half of 2023. “People will put off deals for so long,” Gorman said. “Eventually the traffic jam begins to break.”

For the remainder of 2023, Key’s gain engines will operate closer to neutral than high gear. Khayat predicted further modest declines in net interest income in the third and fourth quarters. Key’s net interest margin decreased 35 basis points in the quarter to 2.12% as of June 30. Although Khayat forecast a relatively stable third quarter with an upward margin in the last three months of 2023, some analysts still expressed surprise at the second quarter figure.

“The margin is so thin here,” Wells Fargo Securities’ Mike Mayo said on the call.

Brian Foran, who covers Key for Autonomous Research, likened Key’s earnings report to a tale of bad news before good news, but the numbers might not deserve the positive spin, Foran added.

“This one looks like a much larger earnings reset than its peers,” Foran wrote in a research note Thursday. “Like it’s just bad-news-is-bad-news.”