DBRS Comments on KeyCorp’s 3Q12 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 3Q12 results. The trend on all ratings is Stable. Reflecting some noise, including the application of new OCC guidelines and several non-recurrent gains and charges, KeyCorp’s 3Q12 net income available to common shareholders decreased 7% to $214 million from $231 million in 2Q12. Specifically, lower sequential earnings reflected a sizable $88 million increase in provisions for loan loss reserves and a 2.8% increase in noninterest expense, partially offset by a 9.0% increase in total revenues.

Despite the difficult operating environment, Key reflected some positive balance sheet trends during 3Q12. The Company’s loan portfolio has grown for four consecutive quarters, including 2.5% growth during 3Q12 (1.1% organically, excluding its recent branch and credit card portfolio acquisitions). Additionally, Key’s asset quality continued to improve, reflecting lower levels of nonperforming assets (NPAs).

Key’s 3Q12 earnings reflected several items and events, including the impact of the application of new OCC guidelines pertaining to exposures to borrowers who have gone through a Chapter 7 bankruptcy and the acquisition of 37 branches in Western New York state (primarily in the Buffalo and Rochester markets). Additionally, in 3Q12 Key re-acquired its Key-branded credit card portfolio, redeemed $707 million of trust preferred securities, and terminated two leveraged leases.

DBRS notes that the new guidance from the OCC led to an incremental $45 million increase in both net charge-offs (NCOs) and provisions for loan loss reserves. Moreover, the higher provision for 3Q12 reflected the establishment of a $29 million allowance for the acquired credit card and branch portfolios. Excluding the impact from the regulatory guidance, Key’s NCOs declined 16.9% from 2Q12 to 51 bps of average loans. Meanwhile, NPAs declined 4.4% to $718 million or 1.39% of loans and OREO during 3Q12, including the impact of the regulatory guidance. Finally, KeyCorp’s reserve coverage of period-end loans remains sound at 136% of nonperforming loans at September 30, 2012.

Despite the continued low interest rate environment, KeyCorp successfully avoided margin contraction, during 3Q12. Indeed, the Company’s net interest margin (NIM) widened 17 bps to 3.23%, QoQ, and contributed to a 6% increase in spread income to $578 million, despite modestly lower average earning assets. The higher margin mostly reflected lower funding costs, driven by the redemption of trust preferred securities, maturing higher cost long-term debt and certificates of deposits. Average earnings assets decreased by 0.2% linked-quarter, reflecting lower levels of securities and short–term investments. Despite the low rate environment, Key’s management expects NIM for 4Q12 to further improve to the low 3.30% range.

On a linked-quarter basis, noninterest income increased 12% to $544 million, in part reflecting a $54 million gain associated with the redemption of its trust preferred securities and an $8 million increase in gains related to early termination of leveraged leases. Meanwhile, core earnings reflected higher levels of trust and investment income (up 4%) and deposit service charges (up 6%).

Higher noninterest expense was driven by a $22 million increase in personnel expense and $8 million of amortization of the intangible assets associated with the credit card and branch acquisitions. Positively, management believes that they are on track to meet their goal of reducing annual expenses by $150 million to $200 million by the end of 2013.

On a core basis, (including leveraged lease items), Key’s DBRS-calculated adjusted income before provision and taxes increased by 14.0% to $325 million, QoQ, driven by a 5.2% increase in adjusted revenues, partially offset by a 1.7% increase in adjusted expense.

The Company’s capitalization remains ample, as evidenced by its strong regulatory and tangible capital ratios including its estimated Tier 1 common ratio of 11.43% and tangible common equity ratio of 10.39%. Utilizing some of its excess capital, Key repurchased 9.6 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 10.5%.

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: Roger Lister
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.