DBRS Downgrades KeyCorp to A (low); Trend is Negative

DBRS has today downgraded the long and short-term ratings of KeyCorp (Key or the Company), including Key’s Issuer & Senior Debt rating to A (low) from “A”, and the long-term ratings of its operating bank subsidiary, KeyBank N.A. to “A” from A (high). The trend for all long-term ratings and the Short-Term Instruments rating for KeyCorp are Negative. At the same time, DBRS confirmed the short-term R-1 (low) ratings of KeyCorp. Key Nova Scotia Funding Company’s Senior Unsecured Notes were downgraded to A (high) from “A” with a Negative Trend and Commercial Paper from R-1 (middle) to R-1 (low) with a Stable Trend. DBRS also confirmed all FDIC-Guaranteed AAA debt ratings with a Stable Trend.

The downgrade reflects Key’s struggle with steep asset quality deterioration over the past two years (total net chargeoffs of 2.65% in Q1 2009) and DBRS’s expectation of further declines in the credit quality of the Company’s commercially-focused loan portfolio through 2009 as suggested by the 42% quarterly growth in nonperforming loans which were beyond DBRS’s expectations. The $2.5 billion in loan loss provisions taken in the past four quarters were roughly 1.8 times the Company’s income before taxes and provisions of roughly $1.4 billion (excluding $688 million in goodwill impairment and $380 million in leverage lease charges). DBRS notes that Key has been proactive in managing its credit issues including building its work-out infrastructure and moving to exit underperforming loan categories from early indications of the crisis. Nonetheless, the Company has been unable to reverse the deterioration and has been drawing on capital to build reserves in the past four quarters. The Company’s revenues, income before tax and provisions (IBPT) and earnings are also likely to be subdued throughout 2009 according to DBRS.

KeyCorp’s ratings are supported by a community banking-focused commercial banking franchise with historically diverse yet stable revenues. In addition to its national commercial banking businesses, the Company is also geographically diverse with nearly 1,000 branches in 14 states in the Northeast, Great Lakes and Northwest and Rocky Mountain regions.

The negative trend on Key’s ratings reflects DBRS’s perception that significant amounts of potential losses remain embedded in the Company’s loan portfolios. Despite having already charged-off a substantial amount of loans in this credit cycle, DBRS believes that Key faces further economic challenges from the ripple effect of falling real estate values and rising unemployment on commercial borrowers. Although the Company has significantly tightened its lending criteria and underwriting, DBRS expects rising credit costs in the coming quarters from legacy credit in the Company’s $25 billion book of commercial loans and $18 billion in real estate and construction loans. DBRS noted, however, that Key’s rating resiliency is substantial given its current placement in the upper quartile of its current rating range. Above average loan quality and revenue generation could return the trend to Stable while continued credit deterioration and losses beyond IBPT and/or significant revenue declines could result in negative rating actions.

Key generated moderate organic deposit growth of 1.3% in the quarter and 6.1% over the year as consumers continued to migrate to CD products and commercial customers increased DDA balances to reduce fees and maintain liquidity. The Company continues to put more focus on its deposit products and is involved in a multi-year project to revitalize its branch network by building new branches, updating others, and upgrading its teller platform technology. Core deposits funded 70% of loans held for investment at March 31, 2009, an improvement from 68% one year earlier. Given the size of Key’s exit loan portfolios, DBRS does not expect loan growth in the near term.

Capital ratios remained solid despite absorbing significant losses due to Key’s proactive efforts to enhance its capital including common stock, preferred stock and trust preferred issuance last year, in addition to TARP preferred issuance and most recently, an announcement of further reduction of its dividend. DBRS believes that capitalization will be under further pressure, however, as asset quality continues to deteriorate. Tier 1 capital ratio improved 24 basis points (bps) to 11.16% and tangible common equity to tangible assets ratio (TCE) increased 11 bps to 6.06% at March 31, 2009 compared to December 31, 2008 primarily from a reduction in tangible assets.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.