KeyCorp: Well Capitalized And Positioned For Growth In 2025

seekingalpha11-22

KeyCorp shares have surged 55% in the past year, driven by solid underwriting, an equity investment, and hopes for easier regulations.The Scotiabank equity stake deal allows KeyCorp to reposition its ...

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Robert Way  Shares of KeyCorp (NYSE:KEY) have been an excellent performer over the past year, adding 55%, thanks to solid underwriting, a significant equity investment, and more recently hopes for an easier regulatory environment. I have viewed KEY as one of the more attractive regional banks, rating shares a “buy” in July, and since then, the stock has added 23% while the market gained 7%. Given several major developments since then, now is a good time to revisit Key, especially with shares above my $18 target. I remain bullish. Seeking Alpha The major development for Key since my last write-up was its decision to sell an equity stake. Scotiabank is investing $2.8 billion in KEY for a 14.9% stake. It paid an 11% premium at the time of the purchase, or $17.17 per share, though Scotiabank’s own timing has proven wise given shares are $19. KEY received $821 million in August, and it expects to receive the rest of the Scotiabank proceeds in Q1. Key, like essentially every regional bank, has been weighed down by buying fixed income securities back when yields were lower. This fixed income portfolio has capped interest revenue and compressed net interest margins (NIM) as rates have risen. At the same time, banks have been saddled with significant unrealized losses. Realizing these losses would erode their capital as AOCI losses only need to start to be gradually phased in starting in January. Essentially, banks need to wait for the bonds to mature to redeploy proceeds into higher yielding securities. However with the Scotiabank infusion, KEY can take this new capital to fund the realization of losses and boost net interest income. The first injection allowed the company to sell $7 billion of securities at a 2.3% average yield and duration of 6 years, taking a $700 million loss. This trade was nearly 20% of its securities portfolio. This repositioning will boost Q4 net interest income by $40 million, after providing a $12 million Q3 benefit. This represented half of its planned portfolio restructuring. As a result, its portfolio yield jumped by 28bps to 2.89%.   KeyCorp KEY is making an extra 260bps on this $7 billion, while also being invested in more liquid and less capital intensive securities. It will do a similar amount of repositioning when the rest of the deal closes in early 2025. Now, because of its equity sale to Scotiabank, its share count is up 5% to 991 million. Even with the dilution, the boost to net interest income from this repositioning should add about $0.04 to Q4 EPS. Not only has Key been able to accelerate its transformation, it has done so in an accretive fashion thus far. In total, I expect the injection to boost EPS by about $0.25-0.35 next year. Beyond this Scotiabank investment, Key is performing solidly. In the company’s third quarter reported on October 17th, KEY earned $0.30 on an adjusted basis, beating consensus by $0.08. On a GAAP basis, it lost $0.47 due to its portfolio repositioning. I view stable and growing deposits as essential in the sector, and KEY meets this threshold with client deposits up 4% from last year. Key has $147.8 billion of deposits, up by $3.6 billion sequentially and $3 billion from last year. It added $1 billion of brokered CDs as it replaces wholesale funding. As you can see below, deposit costs rose by 11bps, but that is because it issued higher-cost deposits to pay down $4.5 billion of even higher cost wholesale funding. As such, funding costs only rose by 1bp.   KeyCorp Moving its funding mix away from wholesale funding and to deposits is a favorable mix shift in my view, even as it makes it appear as though deposits are more expensive. In fact, it was able to pass on over 30% of the 50bp September rate cut, better than initially assumed. I expect this to moderate next year given a still-competitive funding environment. Additionally, KEY is even seeing signs that non-interest-bearing balances are “starting to stabilize.” With the strong deposit performance, KEY has significant liquidity and a loan-to-deposit ratio of just 71%. There continues to be limited demand from businesses for loans, given the rate environment. As such, average loans fell by 2.5% sequentially to $106.2 billion, primarily driven by lower business lending. Given higher origination yields, the yield rose by 7bps to 5.73%. Businesses are using just 31% of their potential borrowing capacity. With the potential for looser regulatory oversight around deal-making, I would expect lending to improve next year, especially as KEY has capital to grow. Its existing loan book is high quality with 70bps of nonperforming assets, though this has been trending up modestly. Key has just 13% exposure to commercial real estate (\"CRE\"), one of the smallest exposures in the industry, limiting potential losses. It carries $1.77 billion of allowances. This 243% coverage is in keeping with my ~250% target for strong reserves, and I expect only modest further builds.   KeyCorp In Q3, Key generated $964 million in net interest income, up 7% sequentially. This included $12 million from the securities repositioning and $46 million from swaps and short-term treasuries maturing. NIM expanded by 13bps to 2.17%, up 16bps from last year as well, as the Scotiabank deal begins paying dividends.   KeyCorp Beyond repositioning, Key will also benefit from maturing swaps. In Q3 and Q4, its swaps yield just 2.3%, but they rise to 3.1% next year. This will provide a meaningful tailwind to results that should continue into 2026 given swap maturities. I expect Key to generate at least $1.02 billion in NII in Q4 as a result. This should ramp toward $1.2 billion by late next year, due to another round of repositioning in Q1 and maturing swaps. This assumes getting NIM to about 2.6-2.80%, still below the company’s 2.8-3% target, which I view as more attainable in 2026 when the swap headwind is further reduced.   KeyCorp Generating faster loan growth can also speed NIM expansion, but that does not appear imminent. Given Q3 results, Key sees loans down 5-6% from 4-5% previously, while deposits will be up 1-2% from flat previously. This leaves the company with even more liquidity. I expect there to be some increase in M&A activity, given the election, but it will likely take 6-12 months for this to boost loan balances, making loan growth a clearer possibility in 2026. Finally, Key is now extremely well capitalized, with a common equity tier 1 (\"CET1\") capital ratio of 10.8%. This was up 35bps sequentially. This understates the improvement in Key’s economic position given the realization of losses. Including AOCI losses, its capital position is 8.6%, up 130bps sequentially. It still has $3.3 billion in AOCI; it expects 40% of this to close by the end of 2026 given asset sales and bonds maturing. As such, I expect Key to be north of 9.5% adjusted capital by late next year, which could enable repurchases. Now, any investment carries risk, and Key is no exception. I would note that Scotiabank's next 10% investment is subject to regulatory approval; given the speed of closing the first tranche and the lack of antitrust issues, I see no issue. There is always the potential approval takes a bit longer, delaying Key's ability to reposition its portfolio. Given its relatively light CRE exposure, I see limited risk here. However, its loan book is more focused in business lending; as such, a typical corporate recession could increase losses. A recession is not my base case but would reduce earnings. Finally, a major part of the Key bull case is an improving net interest margin. With the majority of its loans floating rate, Key will need to pass on at least 25% of Fed funds rate cuts to depositors to avoid contracting NIM. Sticky deposit pricing could reduce EPS by $0.05-$0.10. Back in July, I saw earnings of $1.80 in 2025. Now, there will be significant noise around GAAP results because it will continue to realize losses in H1 funded by the Scotiabank stake. It may also take some time to deploy all of the capital, as Scotiabank is providing more than will be initially needed to reposition its securities portfolio. Key should, however, exit next year with at least $2 in earnings power. While there are risks as noted above, I view them as priced in given its valuation.  This should push shares towards $20-22 or 10-11x earnings. Combined with its 4.3% dividend yield, Key is poised to deliver a 10-15% return for investors. Importantly, with its capital infusion, Key is relatively immune from AOCI challenges, and its loan book has limited CRE exposure. This leaves Key extremely well positioned for a period of higher-for-longer rates with capital to ride out volatility. I view Key as a best-in-class company, and shares are attractive.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2485417909"}