DBRS Comments on KeyCorp’s 1Q11 Earnings; Sr. at BBB (high) Unchanged; Trend Stable

DBRS Inc. (DBRS) has today commented that its ratings for KeyCorp (Key or the Company), including its BBB (high) Issuer & Senior Debt ratings are unchanged after the announcement of the Company’s 1Q11 earnings. The Company reported net income available to common shareholders of $173 million (after $49 million preferred dividends and amortization), compared to $279 million in 4Q10 and a loss of $96 million in 1Q10. DBRS views the Company’s quarterly financial results and overall financial profile as adequate. Nonetheless, core revenues and earning trends are still reflecting some weakness due to challenges in loan growth and the low interest rate environment. Positively, Key continues to proactively de-risk the balance sheet by reducing exposures to higher-risk lending categories. Moreover, the Company repurchased the $2.5 billion in preferred shares held by the U.S. Treasury under the TARP capital purchase program, after successful completion of a $625 million common equity offering and a $1 billion senior debt offering. Following the TARP repayment, DBRS notes that capital remains solid with the Company’s estimated Tier 1 common equity and Tier 1 risk-based capital ratios of 10.70% and 13.44%, respectively.

DBRS comments that first quarter results exemplified the continued improvement in credit trends that have lowered credit costs. Specifically, Key’s provision for loan and lease losses was a credit of $40 million, which bolstered results. Credit quality improvements were evident in all 1Q11 metrics (including its exit loan portfolio) with nonperforming assets (NPAs), net charge-offs (NCOs) and problem loans 90 plus day delinquent all declining during the quarter. Specifically, NPAs sequentially declined by $249 million or 18.6% to 1.82% of period-end loans. Meanwhile, NCOs declined by $63 million to 1.59% of average loans compared to 2.00% in the prior quarter. DBRS views positively that Key’s CRE-related loan NCOs continued to decline (8.8% on a linked-quarter basis) with improvements in CRE mortgage loans partially offset by the slight increase in the commercial construction NCOs. DBRS notes that CRE-related loans comprised 21.9% of the Company’s total loan portfolio, yet made up 44.2% of total NPLs and 37.8% of total NCOs in 1Q11. Positively, the Company’s exit portfolio, at $5.0 billion, continued to decrease (6.3% over the quarter) and accounted for 21.2% or $41 million of its total NCOs.

Despite further declines in the Company-wide allowance for loan losses, Key’s reserves remain adequate in DBRS’s view. Loan loss reserves continued to contract and were $1.4 billion in the quarter. Despite lower loan loss reserves, the coverage ratio of reserves to non-performing loans has increased to 155%, reflecting the improvement in asset quality. At 2.83%, DBRS believes that the allowance for loan and lease losses continues to provide a solid protection layer against unexpected losses.

Net interest income decreased $31 million or 4.9%, in the quarter to $604 million, driven by a reduction in interest yields and a 2.8% contraction in average earning assets. Meanwhile, average loans declined 3.0%, or $1.5 billion, in 1Q11, with 83% of the decrease attributable to CRE loans and the exit portfolios. DBRS expects further pressure on net interest income from weak loan demand and a decline in the average loan balances projected from exit portfolios. Positively, the pace of decline in the exit portfolios has slowed and stabilization has been achieved in some of its loan categories. Management anticipates loan balance stabilization in 2H11, particularly in the real estate book. In DBRS’s view, improved funding costs should somewhat offset the negative impact from continued tepid loan demand. Net interest margin (NIM) declined 6 bps sequentially to 3.25%, impacted by hedge maturities and the change in the funding mix and lower levels of earning assets. Management anticipates NIM in 2011 to be in the range of 3.15% to 3.25%.

On a sequential quarter basis, noninterest income declined 13.1%, or $69 million, to $457 million. Although representing a still solid 43% of total revenues for 1Q11, noninterest income were impacted by a $20 million reduction in investment banking and capital markets revenue, $15 million less of corporate-owned life insurance revenue, as well as net securities losses of $1 million in the quarter, which more than offset a $41 million improvement in net gains (losses) from principal investing. In 4Q10, fee income included a $28 million gain from the sale of Tuition Management Systems and net gains on sale of investments of $12 million. DBRS anticipates the Company’s fee revenue to be further pressured as the Durbin Amendment (if passed in its current form), scheduled to take effect in the second half of 2011, could have a negative impact of approximately $75 million on Key’s $100 million of interchange fees and underscores the revenue headwinds facing Key in 2011.

Benefiting from Keyvolution, the Company’s expense control initiative, expenses declined $43 million or 5.8% sequentially. This initiative has achieved $317 million in annual run-rate cost savings through 1Q11, and is in line with management’s savings goal of $300 million to $375 million.

Following the equity raise and repayment of TARP, the Company’s regulatory and tangible capital ratios remain ample and prepare Key to be well-positioned for a successful transition for Basel III. DBRS believes Key’s capital levels remain solid and reflect positively on the Company’s careful capital management efforts thus far. Nonetheless, DBRS is also mindful that weaker earnings and a potentially higher dividend, if approved by Key’s board of directors, could potentially pressure capital metrics.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids, all of which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: William Schwartz
Approver: Alan G. Reid
Initial Rating Date: 25 April 2003
Most Recent Rating Update: 31 March 2011

For additional information on this rating, please refer to the linking document below.