DBRS Comments on Q2 Earnings of KeyCorp – Senior at A (low); Negative Trend Remains Unchanged

DBRS has today commented on the Q2 2009 earnings and operating performance of KeyCorp (Key or the Company). Key’s Q2 2009 results, while weak, were at the low end of DBRS’s expectations; thus its ratings including Issuer & Senior Debt at A (low), and Negative trend remain unchanged.

On May 1, 2009, DBRS downgraded Key’s Senior Debt to A (low) and left the trend on Negative. The negative trend on the Company’s ratings reflects DBRS’s view that significant amounts of potential losses remain embedded in the Company’s loan portfolios, especially given the current macroeconomic challenges, particularly declining real estate valuations, rising unemployment and the impact of those challenges on consumer-related corporate businesses. DBRS noted that Key’s ratings remain under pressure, as continued credit deterioration, losses exceeding income before provisions and taxes (IBPT), and/or a sustained decline in core earnings power would likely result in negative rating actions.

In 2Q 2009, the Company produced its fifth consecutive quarterly net loss due to elevated credit costs. The quarter produced higher nonperforming assets, but also reflected a slowing in early stage (30 to 89 day) delinquencies. Quality of earnings were also weak as flat net interest income with slight net interest margin (NIM) compression (3 basis points) was accompanied by flat adjusted noninterest income and higher expenses from higher collection costs as Key’s operations continued to be less efficient than peers. The Company was the beneficiary of a dramatic change in depositor behavior, with strong quarterly average deposit growth of 4.4% and average noninterest bearing deposits rising a robust 12.5%. Saving and accumulating cash for contingencies has become a new priority for consumers and businesses, while low interest rates de-motivated depositors from seeking yield leaving balances in DDA accounts. On the other hand, loan demand was very weak in the quarter with average loans (excluding exit portfolios) contracting 3.0% while nonperforming assets grew nearly 28%.

A net quarterly loss of $226 million (before $164 million in cash and deemed preferred share dividends) was an improvement compared to the $488 million loss in the prior quarter and the 1,126 million loss in Q2 2008. The improvement over the prior quarter primarily reflected the $196 million charge to goodwill impairment in the first quarter and $1,011 million (after-tax) in charges related to leveraged lease transactions in Q2 2008. The results continue to be ‘noisy’ reflecting many one-time adjustments, gains and charges to earnings.

Loan quality deterioration continued as nonperforming loans rose almost 26% (not including restructured loans) in the second quarter to 3.09% of total loans. However, while 90 day past due loans increased a similar nearly 27% in the quarter, 30 to 89 days past due loans fell (improved) nearly 17% from $1,407 million to $1,169 million over the quarter. The loan loss reserve declined, but still covers 114% of nonperforming loans including the $311 million reserve build in the quarter. The allowance ratio to all loans, however, did increase to 3.53% of loans at June 30, 2009 compared to 2.97% at Q1 2009.

Loan quality continued to deteriorate further in the quarter across all asset classes and nonperformers are expected to remain elevated for at least the balance of the year. Net charge-offs in the second quarter grew 9.6% to 2.99% of average loans (annualized) from 2.65% in Q1 2009 due to continued losses in commercial mortgage and construction loans and to a lesser extent, home equity and education loans. Nonperforming loan inflows came primarily from real estate construction and commercial real estate loans but were up to a lesser extent in nearly every category. DBRS noted that continued high credit costs exceeding IBPT and/or a sustained decline in core net revenues would likely result in negative ratings pressure.

Provisioning expense was $850 million in Q2 2009, a 2.9% decrease over $875 million in Q1 2009, but $203 million higher than in Q2 2008. The provision was $311 million above net charge-offs in the quarter signalling the Company’s expectation of further loan deterioration.

The Company’s capital actions in the quarter (including an equity raise, preferred stock and capital security exchanges, gains on the sale of securities and dividend/interest savings) raised $1.872 billion in common equity exceeding its SCAP target and substantially increasing its capital ratios. Tier 1 capital ratio rose to 12.42% from 11.22% in the first quarter and KeyCorp estimated it to be 9.93% excluding the TARP capital. Tier 1 common was reported at 7.27% and Tangible common equity at 7.35% of Tangible assets while Total capital ratio was 16.47% clearly reflecting the higher capital cushion that the Company has built that is especially noteworthy for its asset size. Moreover, Key’s July 8, 2009 offer to exchange common stock for certain trust preferred securities could raise Tier 1 capital by an additional 50 bps if completed successfully.

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.