KeyCorp Outshines Estimates

KeyCorp (KEY - Analyst Report) reported its second quarter 2012 net income from continuing operations of 23 cents per share, surpassing the Zacks Consensus Estimate of 18 cents. The results also compared favorably with the prior-quarter earnings of 21 cents.

Including discontinued operations, the company’s net income for the reported quarter came in at $231 million or 24 cents per share as against $194 million or 20 cents in the prior quarter

Stable non-interest income, continued improvement in credit quality and robust capital ratios were the primary highlights for the quarter. However, dwindling net interest income and escalating operating expenses slightly subdued the results.

Quarter in Detail

For the quarter under review, total revenue came in at $1.03 million, slipping 0.2% from the prior quarter. However, this exceeded the Zacks Consensus Estimate of $1.00 billion.

Tax-equivalent net interest income totaled $544 million, declining 2.7% from $559 million in the prior quarter. Net interest margin (NIM) also fell 10 basis points (bps) sequentially to 3.06%. The decline in NIM was attributable to increased write-off of fees and capitalized loan origination expenses from the early termination of leveraged leases, coupled with reduced reinvestment yields. However, declining cost of funds partially mitigated the effects of the abovementioned factors.

Non-interest income surged 2.8% sequentially to $485 million. The sequential upliftment was a result of elevated gains on leased equipment, net gains from loan sales, partly mitigated by lower net gains from principal investments.

Non-interest expense inched up 1.6% from the prior quarter to $714 million. The rise was mainly attributable to increased business services and professional fees as well as higher provision for losses on lending-related commitments.

Credit Quality

Credit quality continued to display an improvement during the quarter. Non-performing assets, as a percentage of period-end portfolio loans, OREO assets as well as other non-performing assets dipped 4 bps sequentially and 47 bps year-over-year to 1.51%. Also, net charge-offs as a percentage of average loans fell 19 bps sequentially and 48 bps year over year to 0.63%.

KeyCorp’s allowance for loan and lease losses was $0.89 billion or 1.79% of period-end loans as of June 30, 2012, compared with $0.94 billion or 1.92% of period-end loans as of March 31, 2012 and $1.23 billion or 2.57% of period-end loans as of June 30, 2011.

However, provision for loan and lease losses came in at $21 million compared with $42 million in the prior quarter and a credit of $8 million in the prior-year quarter.

Capital Ratios

Capital ratios continued to strengthen during the reported quarter. KeyCorp's tangible common equity to tangible assets ratio was 10.44% as of June 30, 2012, compared with 10.26% as of March 31, 2012 and 9.67% as of June 30, 2011. In addition, Tier 1 common equity ratio was 11.68%, compared with 11.55% at the end of the prior quarter and 11.14% at the end of the prior-year quarter.

KeyCorp originated approximately $10.3 billion in new or renewed lending commitments to consumers and businesses during the quarter compared with $8.3 billion issued in the prior quarter.

Capital Deployment

During the quarter, KeyCorp bought back 0.5 million shares at an average cost of $7.83 per share. The company also hiked its quarterly dividend by 66.7% to $0.05 in the second quarter of 2012.

Expansion Plan

In July, KeyCorp completed the acquisition of 37 retail banking branches in Buffalo and Rochester, NY from First Niagara Financial Group (FNFG - Snapshot Report). The deposits and loans associated with these branches amounted nearly $2.4 billion and $400 million, respectively.

Peer Performances

M&T Bank Corporation’s (MTB - Analyst Report) second quarter 2012 earnings significantly surpassed the Zacks Consensus Estimate. The results were aided by increased net interest and non-interest income as well as lower operating expenses.

Mortgage banking revenues posted a decent improvement in the quarter. Moreover, improved capital ratios reflected the company’s strong capital position. However, the mixed credit metrics were the dampeners.

Another peer, Northern Trust Corporation (NTRS - Analyst Report), reported its second-quarter results below the Zacks Consensus Estimate. On a sequential basis, the results were marked by higher non-interest income and strong new business. Moreover, a decline in non-interest expenses and improved credit quality were the positives for the quarter. The fall in net interest income acted as the headwind.

Our Take

KeyCorp’s extensive capital deployment activities will reinforce investors’ confidence in the stock. Moreover, the company’s business restructuring actions will likely continue to propel its credit quality and liquidity.

Also, the company’s strong capital position will facilitate acquisitions in the near term. However, the prevailing unfavorable economic scenario and the shrinking core portfolio of the company, fueled by weak demand and high competition, are the major concerns.

KeyCorp currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Also, based on the fundamentals, we maintain a long-term Neutral recommendation on the shares.