DBRS Comments on KeyCorp’s 4Q11 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 fourth quarter 2011 earnings. For the quarter, Key reported net income available to common shareholders of $194 million, down $18 million from 3Q11.

DBRS sees the fourth quarter financial results, though down from 3Q11, as mostly reflecting a quarter of good measured progress for Key as loan and net interest income growth coupled with a strong credit performance and strong capital were only partially offset by rising expenses that constrained earnings. Importantly, Key marked the second consecutive quarter of period-end loan growth, increasing 2.9% over the quarter. Commercial, Financial and Agricultural average loans rose for the third consecutive quarter, posting a robust 5.4% growth rate in 4Q11.

Also noteworthy is the Company’s recent announcement of an agreement to acquire 37 HSBC Bank USA branches from First Niagara. DBRS expects that the transaction, which is anticipated to close late in 2Q12, will significantly enhance Key’s presence in the Buffalo and Rochester markets and will include approximately $2.4 billion in deposits and $400 million in loans.

DBRS remains mindful that core revenue growth remains a dual challenge for the Company with its sizable runoff portfolios and the current low-growth macroeconomic environment. DBRS-calculated income before provisions and taxes (IBPT) adjusted for one-time items was $294 million in the quarter, down 12%, or $39 million sequentially and down 21%, or $77 million from 4Q10 primarily from the decline in revenues. Positively, Key was able to grow net interest income $8 million, or 1.4% to $563 million over the quarter as lower deposit and borrowing costs coupled with lower balances on low yielding short-term investments resulted in a 4 bps improvement in the net interest margin (NIM) to 3.13% as average earnings assets were flat. Far less favorable, however, is the comparison to 4Q10’s net interest income of $635 million from both higher earning asset and NIM levels. Management’s expectation for 2012 is for modest NIM improvement and for average earning assets to remain in the range of $71 billion to $73 billion.

Fee revenues decreased 4.7%, or $22 million from 3Q11 and 7.8% from 4Q10 to $448 million and were 44% of total 4Q11 revenues (adjusted for the one-time VISA-related and capital security redemption items). Both comparisons were impacted by the $13 million and $15 million declines in electronic banking fees respectively, as new debit interchange regulations from the Durbin Amendment took effect. The swing to an $8 million loss from principal investing in 4Q11 compared to a $34 million gain in 3Q11 and the $9 million increase in gains from loans sales were additional factors in comparing 3Q11 to 4Q11.

Expense control remains a key focus of the Company as it strives to generate positive operating leverage despite rising business operating costs. Noninterest expense increased 4%, or $25 million from the prior quarter to $717 million primarily due to higher business service and professional fees, miscellaneous, marketing and personnel expenses partially offset by decreases in the provision for lending commitments. Compared to 4Q10, expenses fell $27 million mainly due to lower FDIC deposit premiums, lower operating lease expense and other assorted items. The fourth quarter efficiency ratio was up 5% over the quarter to 73%, above the targeted range of 60% to 65%, and is higher than many of its peers.

Credit quality continues to improve as was evident in fourth quarter results. NCOs fell for the eighth consecutive quarter to 1.00% of average loans (including discontinued operations) from 1.09% in 3Q11 with improvement expected to continue to a targeted 40 bps to 50 bps NCO (from continuing operations) rate. NPAs declined for an ninth consecutive quarter as new loans placed on nonaccrual status were down 21% to $230 million from 3Q11. As a percentage of loans plus OREO, NPAs (from continuing operations) were 1.73% at December 31, down 16 bps from 1.89%. Near-term delinquency trends were mixed as 90+ day delinquencies rose 9 bps in the quarter to 0.33% after three quarters of consecutive decline yet 30 to 89 day delinquencies fell 10 bps to 0.89%. Given the generally positive trends, Key recorded a 4Q11 provision reversal of $22 million, $32 million better than the 3Q11 $10 million provision.

DBRS continues to see Key’s reserve as providing ample coverage. At December 31, the allowance for credit losses was 2.03% of total loans and 114% of all NPAs (including from discontinued operations). DBRS notes that exit loans, including discontinued education lending, were $10 billion at the end of the quarter, down $390 million from September 30. While net charge-offs on exit loans (ex-education lending) fell $5 million to $22 million q-o-q, nonperforming balances were flat at $119 million.

DBRS views the Company’s regulatory and tangible capital ratios as generally superior and position Key well for the 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 4Q11, Key’s estimated Tier 1 common ratio stood at 11.28%, flat with the prior quarter while its tangible common equity ratio grew another 6 bps sequentially to 9.88%.

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 DBRS Criteria – 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 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 under Related Research.