DBRS Comments on KeyCorp’s 2Q12 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 following 2Q12 results. The trend on all ratings is Stable. Key reported net income available to common shareholders of $231 million for 2Q12, up from $194 million for 1Q12, yet slightly down from $234 million for 2Q11.

KeyCorp’s second quarter results reflected lower credit costs and sustained revenue generation, despite elevated expenses and its sizable, but shrinking run-off portfolio. Specifically, higher QoQ earnings were attributable to a 50%, or $21 million decline in provisions for loan loss reserves, partially offset by a 0.2%, or $2.0 million decrease in total revenues and a 1.6%, or $11 million increase in noninterest expense. The modest decrease in Key’s QoQ revenues was driven by a 2.7% decrease in spread income, mostly offset by a 2.8% increase in noninterest income.

Lower QoQ net interest income reflected a 10 basis point (bp) narrowing of net interest margin (NIM) to 3.06%, partially offset by a 0.8% increase in average earning assets. The narrower NIM was negatively impacted by the flat yield curve, which drove lower loan pricing and securities reinvestment rates. The narrower NIM also reflected the early termination of leveraged leases, which resulted in capitalized loan origination costs. Meanwhile, the Company’s higher average earning assets were mostly attributable to increased levels of short term investments and a modest 0.03% expansion in loans, driven by a 2.5% increase in commercial & industrial loans and a 1.6% increase in home equity loans.

Fee income, which represents a sizable component of total revenue, grew $13 million QoQ, mostly driven by higher gains, including a $10 million increase in gains on loan sales and a $9 million increase in gains on leased equipment. The higher lease equipment gains were related to the early terminations of leveraged leases. Partially offsetting these tailwinds was an $11 million decrease in net gains from principal investing. Although trust and investment services income decreased by $7 million sequentially, most other fee line items were relatively in line with the prior quarter.

DBRS views positively the Company’s announced efficiency initiative, which will focus on strategic sourcing, branch rationalization, procurement and sales and service productivity. The Company anticipates that the initiative will reduce expenses by $150 - $200 million by the end of 2013, after which these costs will be fully reflected in the Company’s run rate.

Key’s higher QoQ expenses were mostly driven by a $13 million increase in professional fees, partly related to the efficiency initiative, approximately $5 million in costs related to the First Niagara branch acquisition and an increase in marketing expenses (up $4 million), driven by the Company’s spring home equity campaign.

Positively, credit quality continues to improve and drive down credit costs. Specifically, NPAs decreased to 1.51% of loans and OREO at June 30, 2012, from 1.55% at March 31, 2012. Lower NPLs were attributable to decreases across most loan types, except for construction (up $2 million) and home equity loans (up $37 million). Higher home equity NPLs reflected the impact of recently attained information regarding the past due status of first mortgages serviced by others, which are ahead of Key’s home equity loans. Meanwhile NCOs declined to 0.63% of average loans for 2Q12, from 0.82% for 1Q12. Finally, the favorable credit trends allowed the Company to reduce its allowance for loan loss reserves 5.9% to $888 million and coverage of period-end loans to 1.79%.

KeyCorp’s capitalization remains ample, as evidenced by its strong regulatory and tangible capital ratios. In 2Q12, Key’s estimated Tier 1 common ratio increased 13 bps over the prior quarter to 11.68% while its tangible common equity ratio increased 18 bps to 10.44%. During the quarter, Key repurchased 10.5 million shares of common stock under its share repurchase program. Lastly, the Company disclosed its estimated Basel III Tier 1 common equity ratio under the Federal Reserve’s NPR to be approximately 10.9%.

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 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Mark Nolan
Approver: Alan G. Reid
Initial Rating Date: 25 April 2003
Most Recent Rating Update: 4 April 2012

For additional information on this rating, please refer to the linking document under Related Research.