DBRS Comments on KeyCorp’s 3Q11 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 third quarter 2011 earnings. For the quarter, Key reported net income available to common shareholders of $212 million, down $22 million from 2Q11. Net income from continuing operations was $234 million in 3Q11, down from $249 million in the prior quarter. DBRS sees this quarter’s results, though down from 2Q11, as reflective of mostly positive trends. Most credit metrics continue to improve, benefiting from the Company’s aggressive exit of higher risk lending activities and a conservative approach to credit resolution. In addition, the Company’s costs remain well-managed and, importantly, Key reported q-o-q growth in total loans for the first time since 3Q08. The Company also continued to strengthen its already solid core capital levels in the third quarter.

DBRS remains mindful that core revenue growth remains a challenge in the current environment. As such, DBRS views positively that Key reported total revenues of $1.0 billion for 3Q11 that were up $14 million from 2Q11. Still, DBRS notes that reported third quarter revenues included a $13 million gain related to the redemption of certain capital securities in the quarter. Key was also able to report a modest increase in income before provisions and taxes (IBPT) in 3Q11. Third quarter IBPT was $346 million compared to $344 million in 2Q11. DBRS sees further run-off of higher cost CDs and additional loan growth as supportive of revenue growth in the coming quarters. While this was the first quarter of growth in overall loan balances since 2008, period-end Commercial, Financial and Agricultural loans increased for the second consecutive quarter, registering noteworthy growth of 5.7% in 3Q11.

The marginal increase in revenues this quarter reflected decent growth in noninterest income that was offset by a decline in net interest income. Fee revenues increased 6.4% from 2Q11 to $483 million and represented 46.5% of total 3Q11 revenues. Outside of the noted redemption-related gain, fee revenue growth was driven by gains in principal investing and higher service charges, which offset a weaker quarter for capital markets and investment banking. Taxable equivalent net interest income declined 2.6% q-o-q to $555 million. A slight decline in average earnings assets and lower asset yields drove the decline. The NIM contracted 10 basis points (bps) from 2Q11 to 3.09%. Management anticipates NIM to be stable or up slightly in coming quarters due to an improved deposit mix and a better asset mix, given growing loan balances.

Expense control remains a key focus of the Company as it strives to generate positive operating leverage. Noninterest expense increased $12 million from the prior quarter to $692 million primarily due to an $11 million decline in the reserve release for unfunded commitments, which flows through operating expenses. The third quarter efficiency ratio was 67%, slightly above the targeted range of 60-65%.

Credit quality improvement was again evident in third quarter results. NCOs fell for the seventh consecutive quarter, 18.7% from 2Q11 to $109 million, and as a percentage of loans, 3Q11 NCOs declined 21 bps to 0.90%. NPAs declined for an eight consecutive quarter as new loans placed on nonaccrual status were down 28.9% from 2Q11 to $292 million. As a percentage of loans plus OREO, NPAs were 1.89% at September 30, down 9 bps from 1.98%. Delinquencies were relatively stable q-o-q. Given these trends, Key’s 3Q11 provision of $10 million, while up from a reserve release of $8 million in 2Q11, was below charge-offs and is expected to remain so in coming quarters. DBRS continues to see Key’s reserve as providing adequate coverage. At September 30, the allowance for credit losses was 2.35% of total loans and 151% of NPLs. DBRS notes that exit loans, including discontinued education lending, were $10.4 billion at the end of the quarter, down $578 million from June 30. While charge-offs on exit loans (ex-education lending) increased slightly q-o-q, nonperforming balances fell $7 million to $119 million.

DBRS views the Company’s regulatory and tangible capital ratios as solid, leaving Key well-positioned for the eventual transition to Basel III. The Company continues to focus on supporting business strategies that maximize shareholder value and maintains a disciplined approach to capital management. At the end of 3Q11, Key’s Tier 1 common ratio stood at 11.34%, up 20 bps from the prior quarter, and its tangible common equity ratio grew another 15 bps sequentially to 9.82%.

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 under Related Research.