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KeyCorp’s (KEY - Analyst Report) first-quarter adjusted earnings came in at 22 cents per share. This was marginally ahead of the Zacks Consensus Estimate as well as the year-ago earnings of 20 cents.

Considering costs associated with the Fit for Growth efficiency initiative, net income attributable to common shareholders came in at $199 million or 21 cents per share. This compares with $194 million or 20 cents recorded in the prior-year quarter.

The slight improvement in earnings was driven by a rise in net interest income and almost stable operating expenses, which were partially offset by fall in fee income. Moreover, continued improvement in asset quality and strong capital ratios were the other highlights of the quarter.

Behind the Headlines

KeyCorp’s total revenue came in at $1.01 million, rising 1.3% from the prior-year quarter. However, it lagged the Zacks Consensus Estimate of $1.05 billion.

Tax-equivalent net interest income (NII) totaled $589 million, climbing 5.4% from $559 million in the prior-year quarter. Likewise, net interest margin (NIM) increased 8 basis points (bps) year over year to 3.24%. The improvements in NII and NIM were primarily driven by a change in funding mix as well as maturity of long-term debt and higher-costing certificates of deposit in 2012.

Non-interest income declined 3.8% year over year to $425 million. The drop primarily resulted from a fall in operating lease income and other leasing gains along with lower net gains from principal investing. These were partially offset by rise in investment banking and debt placement fees as well as other income.

Non-interest expense inched up 0.3% from the prior-year quarter to $681 million. The rise was mainly attributable to increase in personnel expenditure and intangible asset amortization costs. These were partially offset by a fall in marketing expense, operating lease expense and various other miscellaneous expenses.

Credit Quality

Credit quality continued to display an improvement during the quarter. Nonperforming assets, as a percentage of period-end portfolio loans, OREO assets and other nonperforming assets were 1.34%, dipping 21 bps year over year. Also, net charge-offs, as a percentage of average loans, decreased 44 bps year over year to 0.38%.

KeyCorp’s allowance for loan and lease losses was 1.70% of period-end loans as of Mar 31, 2013 and 1.92% as of Mar 31, 2012. However, provision for loan and lease losses came in at $55 million, up 30.6% from $42 million recorded in the prior-year quarter.

Balance Sheet

As of Mar 31, 2013, KeyCorp had total assets of $89.2 billion compared with $87.4 billion as of Mar 31, 2012.

Average deposits came in at $63.6 billion, up 6.7% from $59.6 billion as of Mar 31, 2012. Further, average loans stood at $52.6 billion increasing 6.5% from $49.4 billion as of Mar 31, 2012.

Capital Ratios

Capital ratios continued to remain strong during the quarter. KeyCorp's tangible common equity to tangible assets ratio was 10.24% as of Mar 31, 2013, compared with 10.26% as of Mar 31, 2012. In addition, Tier 1 common equity ratio was 11.39%, compared with 11.55% at the end of the prior-year quarter.

The company’s estimated Basel III Tier 1 common ratio was 10.28% at the end of the reported quarter compared with 10.38% in the previous quarter.

Capital Deployment Activities

In Mar 2013, the Federal Reserve approved KeyCorp’s capital plan following the 2013 Comprehensive Capital Analysis and Review (CCAR). Consequently, the board of directors at KeyCorp announced a $426 million share buyback program through the first quarter of 2014.

Further, KeyCorp will consider a dividend hike in May. The company is looking forward to raising its dividend by 10% to 5.5 cents. The dividend hike, if approved, would become effective second-quarter 2013 onward.

During the quarter, KeyCorp bought back 6.8 million shares worth $65 million. Following these repurchases, the company’s authorization to buyback shares under the 2012 capital plan expired.

Other Developments

In Feb 2013, KeyCorp decided to sell-off its investment management subsidiary, Victory Capital Management and broker dealer affiliate Victory Capital Advisers. The company signed a deal with Crestview Partners – a private equity firm – to vend the subsidiary for $246 million in cash and debt.

KeyCorp stated that of the total sale price, $201 million is in cash, while the remaining $45 million is a seller note, whose final value would be determined by the end of the year. The company anticipates that upon closure, the deal will lead to an after-tax gain in the range of $145–$155 million. Moreover, the sale is expected to be completed by the end of the third-quarter of 2013.

Performance of Other Major Regional Banks

M&T Bank Corporation (MTB - Analyst Report) and Comerica Incorporated (CMA - Analyst Report) reported better-than-expected first-quarter earnings. For M&T Bank, earnings were primarily aided by reduced provision for credit losses, partially offset by rise in expenses and declining top line. Comerica’s results reflected reduced expenses, partly offset by a decline in revenues.

Nevertheless, U.S. Bancorp (USB - Analyst Report) was aided by reduced non-interest expenses and a lower provision for credit losses, as the company’s first-quarter earnings were in line with the Zacks Consensus Estimate.

Our Take

We expect KeyCorp’s business restructuring actions to continue to fuel its credit quality and liquidity. Though the company’s capital deployment initiatives highlight its stable capital position, we remain wary of the persisting slow economic recovery, stringent regulatory restrictions and the low interest-rate scenario. However, we are optimistic on the company’s strong balance sheet and improved market share.

KeyCorp currently retains a Zacks Rank #3 (Hold).

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