DBRS Comments on KeyCorp’s 4Q12 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 4Q12 results. The trend on all ratings is Stable. Key reported net income available to common shareholders of $197 million, an 8% decline from $214 million in 3Q12. The quarter-over-quarter (QoQ) earnings contraction mostly reflected non-core expense associated with its recently implemented Fit for Growth efficiency initiative and the non-recurrence of a 3Q12 gain associated with trups redemption. Specifically, lower earnings reflected a 4.4% decline in total revenue and a 3.0% increase in non-interest expense, partially offset by a 47.7% decline in provisions for loan loss reserves.

Despite the difficult operating environment, Key continued to reflect positive balance sheet fundamentals during 4Q12. Indeed, the Company has reported five consecutive quarters of average loan growth, including 2.3% growth (not annualized) in 4Q12. Moreover, deposit growth was sustained, with average deposits up 2.0% sequentially. Finally, Key’s asset quality remained sound in 4Q12.

Overall the $49 million, or 4.4% decrease in linked-quarter total revenues reflected a 14.3% decline in non-interest income, partially offset by 5.0% increase in net interest income. The decline in non-interest income linked-quarter was mostly attributable to the non-recurrence of a 3Q12 $54 million gain associated with the redemption of certain trust preferred securities, and a $44 million decrease in gains on leased equipment, related to the early termination of leveraged leases in 3Q12. Somewhat offsetting these headwinds, Key reported increased gains on loan sales (up 46.2%), corporate-owned life insurance (up 38.5%) and investment banking & capital markets income (up 23.7%).

Despite the low interest rate environment, spread income increased $29 million, or 5.0% QoQ, driven by a 14 bps widening of NIM to 3.37% and a 0.7% increase in average earnings assets. The wider NIM was mostly driven by lower funding costs and higher loan yields. Lower funding costs reflected an increase in demand and non-time interest bearing deposits, as well as the maturity of higher cost certificates of deposits. Furthermore, NIM benefited from an increase in loan related fees, as compared to 3Q12, when Key wrote-off capitalized loan origination costs of $13 million, resulting from the early termination of leveraged leases.

Meanwhile, higher linked-quarter earning assets reflected a 2.3% increase in average loans, partially offset by a 5.0% decrease in securities. Loan growth was broad-based, led by a $963 million, or 4.5%, increase in commercial & industrial loans, a $92 million, or 1.2% increase in commercial real estate exposure (excluding construction) and a $72 million, or 3.4% increase in residential mortgage loans.

Overall, the $22 million, or 3.0% QoQ increase in non-interest expense was primarily attributable to a $22 million, or 5.4%, increase in personnel expense and a $6 million, or 12.2%, increase in business services and professional fees. Salaries increased QoQ due to an increase in labor for technology related to the 3Q12 credit card portfolio acquisition and new payment systems and merchant services processing. Furthermore, higher personnel expense was driven by higher medical claims expense, an adjustment to the annual retirement contribution accrual and an increase in severance costs associated with Key’s efficiency initiative. Going forward, expense management and efficiency of operations will receive high priority. Overall, 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.

Credit quality remained sound, despite macroeconomic headwinds. Key reported a moderate $17 million, or 2.4% QoQ increase in non-performing assets (NPAs), which represented a solid 1.39% of loans at December 31, 2012, flat with the prior quarter. Meanwhile Key’s NCOs declined to a modest 0.44% of average loans for 4Q12, down from 0.86% for 3Q12. Finally, KeyCorp’s reserve coverage of period-end loans of 1.7% and coverage of non-performing loans at 132% were solid at December 31, 2012.

The Company’s healthy funding profile is underpinned by a loan to deposit ratio of 80%. DBRS notes that recent deposit growth reflected an improved mix, as non-interest bearing deposits increased by 4.8%, while total time deposits decreased by 10.2%.

Capitalization remains ample, as evidenced by Key’s strong regulatory and tangible capital ratios including its estimated Tier 1 common ratio of 11.16% and tangible common equity ratio of 10.15%. Utilizing some of its excess capital, Key repurchased $89 million of common shares under its share repurchase program, which has remaining repurchase authority of up to $88 million. Lastly, the Company estimates its Basel III Tier 1 common equity ratio under the Federal Reserve’s NPR to be approximately 10.2%, which is above the minimum requirement.

Notes:
All figures are in U.S. dollars unless otherwise noted.

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]