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KeyCorp Beats on Higher Revenue

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KeyCorp (KEY - Free Report) reported its third quarter 2012 net income from continuing operations of 23 cents per share, surpassing the Zacks Consensus Estimate of 21 cents. The results were in line with the prior quarter but compared unfavorably with the year-ago quarter earnings of 24 cents.

Including discontinued operations, the company’s net income for the reported quarter came in at $214 million or 23 cents per share, down from $231 million or 24 cents in the prior quarter but up from $212 million or 22 cents in the year-ago period.

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

Quarter in Detail

KeyCorp’s total revenue came in at $1.12 million, rising 9.0% from the prior quarter and 8.1% from prior-year quarter. Moreover, total revenue was 9.3% ahead of the Zacks Consensus Estimate of $1.03 billion.

Tax-equivalent net interest income totaled $578 million, climbing 6.3% from $544 million in the prior quarter. Net interest margin (NIM) also increased 17 basis points (bps) sequentially to 3.23%.

The improvement was attributable to declining funding costs, the redemption of trust preferred securities, maturity of long-term debt, the maturity of higher rate certificates of deposits and acquisition of credit card portfolio. However, these positives were partly offset by write-off of fees and capitalized loan origination costs from the early termination of leveraged leases.

Non-interest income grew 12.2% sequentially to $544 million. The sequential upliftment was a result of elevated trust and investment services income, service charges on deposit accounts, gains on leased equipment, insurance income, net gains from loan sales and other income.

However, these were partly mitigated by lower operating lease income, letter of credit and loan fees, corporate-owned life insurance income and net gains from principal investments.

Non-interest expense inched up 2.8% from the prior quarter to $734 million. The rise was mainly attributable to increased personnel expenditure, net occupancy costs, marketing expenditure, intangible asset amortization on credit cards as well as higher other intangible asset amortization and other expenses.

These were partially offset by a marginal fall in operating lease expense, business services and professional fees, other real estate owned (OREO) expense, net and Federal Deposit Insurance Corporation (FDIC) assessment costs.

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 12 bps sequentially and 50 bps year-over-year to 1.39%. Also, net charge-offs as a percentage of average loans increased 23 bps sequentially, but fell 4 bps year over year to 0.86%.

KeyCorp’s allowance for loan and lease losses was $0.89 billion or 1.73% of period-end loans as of September 30, 2012, compared with $0.89 billion or 1.79% of period-end loans as of June 30, 2012 and $1.13 billion or 2.35% of period-end loans as of September 30, 2011.

However, provision for loan and lease losses came in at $109 million, substantially higher than $21 million recorded in the prior quarter and $10 million in the prior-year quarter.

Balance Sheet

As of September 30, 2012, KeyCorp had total assets of $87.0 billion compared with $86.5 billion at June 30, 2012, and $89.3 billion at September 30, 2011.

Total deposits came in at $64.2 billion, up from $62.2 billion in the prior quarter and $61.0 billion in the year-ago period.

Capital Ratios

Capital ratios continued to strengthen during the reported quarter. KeyCorp's tangible common equity to tangible assets ratio was 10.39% as of September 30, 2012, compared with 10.44% as of June 30, 2012 and 9.82% as of September 30, 2011. In addition, Tier 1 common equity ratio was 11.43%, compared with 11.63% at the end of the prior quarter and 11.28% at the end of the prior-year quarter.

KeyCorp originated approximately $9.0 billion in new or renewed lending commitments to consumers and businesses during the quarter, compared with $10.3 billion issued in the prior quarter.

Capital Deployment

During the quarter, KeyCorp bought back 9.6 million shares worth $82 million. Following these repurchases, KeyCorp has remaining authority to repurchase up to $177 million of its common shares under its new share repurchase program, which has no expiration date.

Expansion Plan

In August, KeyCorp announced a couple of strategic measures to reinforce its consumer and commercial payments businesses. These initiatives include the acquisition of credit card assets worth $725 million from Elan Financial Services and an amendment of its merchant services agreement with Elavon, Inc.

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

Our Take

KeyCorp’s extensive capital deployment activities will continue to reinforce investors’ confidence in the stock. Moreover, the company’s business restructuring efforts are likely to 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. However, considering the fundamentals, we maintain a long-term Outperform recommendation on the shares.

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