DBRS Comments on KeyCorp’s 2Q11 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 rating are unchanged after the announcement of the Company’s second quarter 2011 earnings. The Company reported net income available to common shareholders of $234 million compared to $173 million in 1Q11 and $29 million a year ago. DBRS views the Company’s quarterly financial results and overall financial profile as improving in a challenging operating environment. Earnings were indicative of Key’s continued reduction in credit costs and lower levels of non-interest expense that benefited from the Company’s aggressive exit of higher risk lending activities, conservative approach to credit resolution, and tighter expense control.

DBRS is mindful that core revenues of $1.0 billion declined 3.4% compared to 1Q11 and PPNR of $344 million decreased 4.4% sequentially, pressured by weak loan growth and the low interest rate environment. Positively, sustained improvement in credit quality led by a 69% YoY decline in charge-offs to 1.11% of average loans resulted in an $8 million release of provision for loans losses that continues to provide ample reserve coverage of 2.57% of period end loans and 146% of NPLs at 2Q11.

In the quarter, credit quality improvement was evident in all metrics (including its exit loan portfolio) with nonperforming assets (NPAs), net charge-offs (NCOs) and problem loans 90 plus day delinquent all declining. Specifically, NPAs sequentially declined by $139 million or 12.8% to 1.76% of period-end loans at 2Q11 and decreased 54% from a year ago. Meanwhile, NCOs declined quarter over quarter (QoQ) by $59 million as commercial NCOs improved by $40 million or 34.5%, attributable primarily to real estate related commercial mortgage loan charge-offs that improved $31 million or 72% from 1Q11. NPLs and NPAs were being carried at approximately 64% and 60%, respectively, of total outstanding balances. Key’s exit loan portfolio accounted for $25 million or 18.7% of the Company’s total NCOs and charge-offs in the portfolio decreased by $16 million sequentially from improvement in the marine loan portfolio. Exit loans comprised 9.9% of Key’s total loans at 2Q11 and will continue to be a counterbalance to asset generation. Management anticipates lower levels of NPLs and NCOs in 2H11 and the provision for loan losses is likely to remain below NCO levels given current trends and the level of protection conferred by loan loss reserves.

Although loan growth remains weak, positive balance sheet trends were evidenced by modest loan growth in the quarter. Average Commercial, Financial and Agricultural loans grew 3.7% in the quarter while other loan categories signaled stabilization such as non-exit consumer loan portfolio. Overall, loan balances began to contract at a slower pace, particularly in Commercial Real Estate (CRE) loans that declined 9.3% sequentially and had been running off approximately $900 million QoQ. In addition, Institutional and Capital markets business enjoyed 10% growth QoQ with a large syndication pipeline, indicative of growth in the portfolio. Management believes that the Company is nearing an inflection point of loan compression and anticipates loan growth for the latter half of 2011.

DBRS views the continued stability and loan growth as helping to generate revenue growth in the coming quarters. The marginal decline in revenue reflected relatively flat QoQ non-interest income of $454 million that represented a solid 44% of total revenues, offset by a 5.5% decline in net interest income. Net interest income declined due to a 4.3% contraction in average earning assets attributable to lower levels of loans and securities, repayment of TARP preferred stock and escrow deposit migration in 1Q11, partially offset by lower funding costs from an improved deposit mix. Nonetheless, lower spread income, coupled with excess liquidity invested in lower yielding assets led to a 6 basis point (bps) decrease in net interest margin (NIM) to 3.19%. Management anticipates NIM to be under pressure given the low interest rate environment and its asset sensitive balance sheet.

Net interest expense declined $21 million or 3% to $680 million compared to $701 million in 1Q11. Management notes that Keyvolution targets have been successfully reached and that Keyvolution initiatives are incorporated in the Company’s ongoing operations.

DBRS views the Company’s regulatory and tangible capital ratios as solid, preparing Key to be well-positioned for a successful transition for Basel III. Given its healthy capital position, Key increased its quarterly dividend to $0.03 from $0.01 per common share in the quarter. The Company continues to focus on supporting business strategies that maximize shareholder value and maintains a disciplined approach to capital management. In 2Q11, its Tier 1 common ratio stood at 11.01%, up 27 bps from the prior quarter and Tier 1 risk-based capital at 13.76% climbing 28 bps from 1Q11. The Tangible Common Equity (TCE) ratio grew 51 bps sequentially and 202 bps YoY to 9.67% in the quarter.

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: Roger Lister
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.